What is Know Your Customer (KYC) procedure?
Know Your Customer in the crypto industry is the set of identity verification procedures required by law for virtual asset service providers (VASPs).
In traditional finance, valid credentials include ID card validation, face verification, biometric authentication, and proof of address (for example, a copy of a recent utility bill). However, KYC requirements are less standardised in the crypto world.
Today, most crypto exchanges require that new customers share their full legal name, government-issued ID, and up-to-date address information during onboarding, but this varies depending on where the exchange operates and what services it provides. Some platforms also offer multiple levels of the KYC procedure, each confining users to a specific range of services and trading options and volumes.
For example, as highlighted in many CoinSpot review blogs, the exchange offers different verification tiers. Basic trading and account access are available after completing KYC, but higher trading limits and additional features become accessible only after further verification steps.
What is Anti-Money Laundering (AML) procedure?
Anti-Money Laundering consists of laws, regulations, and practices that are designed to prevent criminals from exchanging money obtained through illegal activities – “dirty money” – into legitimate income or “clean money”.
In 2014, The Financial Action Task Force (FATF) started issuing guidelines on cryptocurrency-related AML. Today, organisations like FinCEN, the European Commission, and many regulatory bodies have codified most of FATF’s AML recommendations into laws.
FAFT shifts the responsibility to virtual asset service providers (VASPs), which FATF defines to include crypto exchanges, stablecoin issuers, and, in some cases, DeFi protocols and NFT marketplaces. When suspicious transactions are detected, VASPs report them to regulators to investigate the flow of funds to find the criminals.
How KYC and AML help protect your funds and trading environment?
The Importance of KYC in Crypto
Here is the great thing about the KYC procedure in the crypto world: Each exchange can develop its own process and requirements for passing KYC. To some extent, it withdraws anonymity from the clients to a certain level but serves other essential purposes. In essence, complying with KYC benefits both the exchange and its clients.
On one hand, the platform obtains the clients’ data, risk profile, and financial situation. On the other hand, the clients get enhanced account protection and a set of advantages for being verified. Let’s take Binance as an example. When this one-of-the-largest crypto exchange made KYC mandatory for all of its customers, the company found that “most people — 96%, 97% of users — go through KYC” during onboarding. This minor reduction in registrations is a small price to pay for the ability to operate in hundreds of regulatory environments, serve millions of customers, and stop illicit activities of every type.
The Importance of AML in Crypto
The cryptocurrency industry is a lucrative market for illegal money laundering activities due to its anonymity and intrinsic encryption of transactions. According to the Chainalysis Crypto Crime Report 2023, in 2022 alone, a staggering $3.8 billion in cryptocurrency was stolen from exchanges and DeFi platforms, which is a 58% increase from the previous year.
Cryptocurrency anti-money laundering laws serve various purposes, and three of the most important ones are:
- Preventing criminal income fund legalisation: Due to the anonymity of crypto transactions, they can be exploited to launder money gained from illegal activities like drug trafficking, weapons sales, and human trafficking. AML measures help to trace and stop such transactions.
- Preventing financing terrorism: Cryptocurrencies can also be used to fund terrorist activities, and AML procedures are designed to prevent such use cases.
- Ensuring regulatory compliance: As governments work to develop regulations for cryptocurrencies, AML measures help enforce control over transactions and ensure compliance with emerging regulatory frameworks.
Effective AML regulations have two important consequences: firstly, they make money laundering less profitable and riskier. Secondly, they open up new paths for prosecuting financial crimes.
Key Challenges of Implementing KYC and AML in the Crypto Industry
Implementing Know Your Customer (KYC) and Anti-Money Laundering (AML) protocols in the cryptocurrency sector poses several significant challenges.
- Privacy vs. Security: KYC and AML protocols are essential for curbing financial crime, but they require users to sacrifice some level of anonymity, which is, to many people in the crypto community, unacceptable.
- Evolving Global Regulatory: The decentralised and global nature of cryptocurrencies significantly hinder regulatory efforts. Different countries have different regulatory frameworks for cryptocurrencies, so exchanges and financial institutions often find themselves navigating a maze of contradictory or unclear international laws. As the CoinSpot review mentions, the exchange has managed to maintain its standing by adhering to the evolving regulatory requirements in Australia, ensuring compliance with the most recent AML laws.
- Managing Vast Amounts of Data: KYC and AML compliance in the crypto space bring a huge challenge: how to manage and analyse such vast quantities of data? Understanding how to effectively monitor and regulate crypto transactions demands sophisticated tools and technologies that are still evolving.
To address these challenges, many financial institutions have been investing in and testing advanced technological solutions. Blockchain analytics tools, for instance, have become increasingly sophisticated to help trace and identify suspicious activities. Additionally, artificial intelligence (AI) and machine learning (ML) are being leveraged to enhance the efficiency of these tools, which make the analysis of large datasets much quicker and more accurate.
