Know Your Customer (KYC) is a requirement for regulated financial services companies to identify their users to mitigate the risk of illegal activities. Read on to learn what KYC verification is, why KYC exists, and why it is considered controversial in crypto.
What Is the Meaning of KYC?
Know Your Customer (KYC) is a standard that requires financial service providers to get detailed information about their clients’ identities, risk profiles, and financial positions.
KYC can be simple or complex, depending on how much information a customer needs to provide. Basic information can include a name, home address, and phone number, while more complex information can include credit worthiness.
KYC is a vital part of compliance requirements for financial service providers, as they are obliged to track and report suspicious transactions. Suspicious transactions could include money transfers with links to money laundering, terrorism financing, and other criminal activities. Financial service providers, under different legal bodies or mandates, must follow prescribed guidelines to identify and report suspicious activities.
What Is KYC Verification?
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 capture 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 demanded. 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.
Why Does KYC Exist?
KYC is a legal requirement that has been put into place with the reasoning that it prevents money laundering and other illegal activities.
KYC 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 their preferences or situations 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 a part of any criminal activity directly or indirectly.
Why Is KYC Considered Controversial in Crypto?
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.
Whether the crypto community like 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.
As such, the cypherpunk ethos of Bitcoin continues to face resistance from a growing crypto ecosystem that largely wants to become fully compliant with the rules found in the highly regulated financial industry.
How does KYC work?
KYC is the process of customers needing to share their personal information before creating a financial service account. Typically, this involves filling out an online form and sending in digital copies of ID documentation.
Can I change my KYC information once it is collected?
You can change your KYC information if there is an error in it. Financial service providers ensure they have up-to-date KYC information for their customers. Some companies require written confirmation of any significant changes in KYC to prevent possible fraud.
Who stores my KYC information?
The service that collects your KYC information will often act as a host or custodian over your personal information. Some companies may share your information, subject to your consent (hopefully), with third parties.
Who protects my KYC information?