What is KYC in crypto? A deep dive

KYC (Know Your Customer) is a requirement for regulated financial services companies to identify their users to mitigate the risk of illegal activities.

In this article, we will learn what is the meaning of KYC in crypto, its importance, regulations, benefits, and the challenges and criticisms faced by KYC In crypto.

What Is KYC in crypto?

KYC verification is the process of authenticating the information provided to a financial institution by customers.

Verification can happen through physical devices such as biometric tools to record a customer’s fingerprint or facial recognition. Web and mobile tools with machine learning functionality can be used as well to confirm customer identities or flag irregular transactions in their systems.

There are different levels of KYC verification, also known as due diligence.

Simple due diligence is the basic level of KYC verification. Basic details such as name and address are required. This type of verification can be done through mobile or email when a client is invited to verify their account. It applies mostly to low-value accounts.

The second type of KYC verification is basic customer due diligence, which includes a fair risk assessment of the customer’s profile. It might involve cross-checking clients’ documentation, for example.

The third type of KYC verification is enhanced due diligence, where an institution can seek further information from a client depending on aspects such as political exposure, and other higher-risk situations such as ties to active police investigations. For comparison and perspective, a politically exposed person (PEP) will need to undergo a more strict examination or monitoring of their financial accounts, than, for example, a college student.

Now that we know what does KYC mean in crypto, let’s find out how KYC in crypto actually works.

How KYC works in the crypto industry

KYC is a legal requirement that has been put into place with the reasoning that it prevents money laundering and other illegal activities.

KYC in crypto proponents also argue that it can be helpful for investors and service providers because it offers clarity and protection in investment decisions.

Customers are protected when, for example, they show a low-risk tolerance, so investment advisors can guide them on options that suit them more appropriately.

Conversely, financial institutions need to manage their risk exposure to fraud, financial crimes, and other high-risk transactions. It is their duty to make sure that such transactions aren’t complicit or found to be part of any criminal activity directly or indirectly. All of this is made possible when KYC in the crypto world is made mandatory.

The importance of KYC for cryptocurrency platforms

The crypto industry is known for its promise of customer anonymity and decentralization. Some cryptocurrencies offer more anonymity than others, for example. By contrast, KYC is known to be subject to a strict set of requirements by a centralized authority. It is also known to be costly in terms of the compliance work that has to be done.

Most cryptocurrency wallets offer pseudo-anonymity in the sense that customers provide limited personal information, such as an email address and a password, to get started. With this, they are free to transact as much and as often as they wish.

Anonymity is a positive attribute, as it provides a measure of safety for people in the sense that they have a lower risk of being exposed to identity fraud while making financial transactions. Criminals, however, exploit this aspect to send and receive funds under the guise of anonymity to facilitate their activities. The question remains on how to leverage the positive aspects of anonymity while minimizing its adverse aspects.

Victims of cybercrime related to cryptocurrency lack backing or protection while transacting on various crypto platforms. A loss of funds, for example, to a scammer, may put investors in a fix, as they have nowhere to turn to in trying to recover their funds.

Hacks that target crypto exchanges and other service providers also draw further calls for the regulation of the crypto industry, which is proving to be more complex as services evolve to circumvent strict regulation.

For the growth of the crypto ecosystem, a necessary evil when it comes to KYC will be to provide just enough transparency to monitor suspicious transactions without hampering the permissionless access that cryptocurrencies offer to the greater public.

This is the heart of controversy regarding KYC in crypto since it’s assumed that every crypto user has a fair understanding of the risks, for example, custodial services and the responsibility of protecting their data. However, for most users who are new to crypto services, this is far from reality.

On the other hand, crypto services envisioning mass adoption stand in the gap between offering services seamlessly and building enough trust with regulators to stay in business in the long run, while minimizing their risk of exposure to fraud, money laundering, and terrorism financing, among other criminal activities.

The crypto community will keep debating how much KYC will be too much KYC for a product or service, so it does not lose its trustlessness, decentralization, and anonymity – which are the ideal attributes of a crypto product.

KYC regulations and compliance requirements

Whether the crypto community likes it or not, more and more KYC requirements will enter the industry as it grows to become a recognized part of the global financial industry. Moreover, many crypto entrepreneurs are pushing for clear regulations, which will inevitably involve KYC, to ensure they can operate within a clearly defined legal framework.

Government organizations frequently enforce KYC laws, and platforms that violate them run the danger of fines or being prohibited from doing business in particular areas. The goal of implementing such restrictions is to give the cryptocurrency industry credibility and increase its integration with conventional finance.

Benefits of KYC in the crypto space

Increasing user and cryptocurrency platform confidence is largely dependent on KYC verification. It aids in the prevention of illicit activities including money laundering, fraud, and terrorism funding.

Exchanges and platforms may make sure that only genuine users are using their services by getting to know their clients. KYC compliance also gives investors more stability and contributes to the general security of the cryptocurrency market.

Additionally, KYC makes it easier for traditional financial institutions and cryptocurrency platforms to communicate. Because of worries about money laundering and other financial crimes, many institutions are reluctant to collaborate with cryptocurrency platforms. Platforms that use KYC processes, however, show that they are dedicated to compliance, which facilitates partnership formation and integration with the conventional banking industry.

The fact that KYC contributes to user protection is another important advantage. By implementing KYC protocols, exchanges can better monitor and detect questionable transactions, lowering the possibility of fraud and scams.

Users may utilize these platforms with greater trust as a result. Furthermore, KYC protects customers by making sure they aren’t inadvertently interacting with websites or people who are engaged in unlawful activity.

Challenges and Criticisms 

Despite its advantages, KYC in cryptocurrency is sometimes attacked for compromising the fundamental privacy and decentralized tenets around which cryptocurrencies were founded. 

Additionally, the process of confirming users’ identities can be time-consuming, and invasive, and result in the gathering of sensitive information that some contend may be exploited or disclosed. 

Furthermore, smaller cryptocurrency platforms and exchanges may find it difficult to maintain KYC processes due to the expense and work required. Additionally, strict KYC rules in some areas may make it impossible for people to use crypto services.

How to complete KYC for crypto exchanges

To complete KYC for a crypto exchange, users generally need to submit personal information such as their name, address, and sometimes a government-issued ID. Some exchanges may also require a selfie or facial verification. 

Depending on the platform and jurisdiction, additional documentation like proof of address may be needed. Once the required information is submitted, the platform will review and confirm the verification.

To ensure quicker and more effective inspections, several exchanges additionally use third-party KYC providers to manage the verification process. Although verification timeframes can vary, they usually range from a few minutes to several days.

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