What does KYC in Crypto mean?
Know your customer (KYC) is the first stage of anti-money laundering (AML) due diligence. When a financial institution (FI) onboards a new customer, KYC procedures are immediately followed to identify and verify the customer’s identity. These processes allow FIs to assess the customer’s risk profile based on their propensity for financial crime.
KYC is a process that cryptocurrency exchanges must use to:
- Confirm their end users’ and customers’ personal information.
- Acquire a better understanding of the activities of their potential customers and verify their legality.
- Determine the probability their customers pose money laundering risks.
What does KYC compliance look like for VASPs?
VASPs undertake a multi-step KYC process to prevent fraudulent activity. The steps are as follows:
- Step 1: Collect their customers’ personally identifiable information (PII), including their full name, place, date of birth, and address.
- Step 2: Compare this information to their official government-issued identification, such as a passport or state-issued driver’s license, and proof of residence, such as a utility bill.
- Step 3: Verify the customer’s identity against official databases that contain information on Politically Exposed Persons (PEP) and sanctioned individuals.
These steps help FIs determine each client's virtual currency money laundering and financial crime risk. If everything checks out, the customer is permitted to engage in certain activities on the cryptocurrency exchange.
What is cryptocurrency transaction monitoring?
A cryptocurrency transaction monitoring system aids crypto exchanges and FIs in identifying unusual or suspicious activity that they must report to regulatory authorities and assists law enforcement in tracking criminals. Transaction monitoring observes the risk associated with a cryptocurrency wallet. Virtual asset exchanges use tools provided by companies like Chainalysis, Elliptic, Crystal Blockchain, Coinfirm, etc.
Do crypto wallets need KYC compliance?
Crypto wallets fall into two categories: custodial and non-custodial (self-hosted.) Only custodial wallets must comply with KYC practices, as they hold the private keys to a customer’s wallet. As mentioned on our VASP page, the Financial Action Task Force (FATF) defines VASPs as “any natural or legal person who exchanges, holds, safe-keeps, sells, converts, or otherwise transfers VAs on behalf of another natural or legal person.” VASPs are now regulated as financial institutions and must have a robust FYC framework. Self-hosted or non-custodial wallets such as MetaMask and Argent do not require KYC. Custodial wallet services associated with a VASP are required to have a KYC compliance program.
What are the benefits of Crypto KYC?
Despite operational adjustments and obstacles that arise when implementing KYC standards, cryptocurrency exchanges benefit significantly from regulatory compliance for the reasons listed below:
- Increased transparency and trust among customers
Verifying user identities benefits transparency and customer trust. When users feel confident that their cryptocurrency exchange is taking proactive and preventive measures to protect their accounts, they are more likely to continue using the service.
- Less money laundering and scams
Between January 1, 2021, and March 31, 2022, more than 46,000 consumers reported losing over $1 billion in crypto to fraudsters. (Fletcher 2022) Vigorous identity verification can significantly reduce fraudulent activity and improve market reputation.
- Reduced legal risk
As legal requirements evolve, robust KYC processes will keep businesses ahead of the curve. KYC methods enable VASPs to prevent/limit fake identity instances, prevent money laundering, and assess customer risk by requiring government-issued identification and identifying financial history and assets. These steps allow businesses to reduce legal and regulatory risks, freeing time to focus on increasing conversion rates, expediting transactions, and ensuring compliance.
- Increased market stability
The cryptocurrency market is notoriously volatile because of suspicious, anonymous transactions. KYC programs that feature increased identity verification contribute to the market’s overall stability and value growth.
Can I buy crypto without KYC?
It is possible to purchase VAs without performing KYC. Crypto ATMs and decentralized exchanges (DEXs) don't require KYC, for example. Crypto ATMs let users buy cryptocurrency using cash or debit cards, whereas DEXs are blockchain-based P2P markets that permit large-scale crypto asset trading. DEXs do this using automated algorithms rather than acting as financial intermediaries.
What are the risks of buying Crypto without KYC?
Buying virtual currencies without performing KYC carries significant regulatory risk. Financial regulators such as The Office of Foreign Assets Control (OFAC) have punished cryptocurrency exchanges for apparent sanctions violations. A platform may detect black market accounts as fake, endangering assets.
Exchanges without KYC
Uniswap and Bisq are widely used DEXs without KYC processes. On these platforms, cryptocurrency sellers are matched with buyers based on order prices and volume, adding and subtracting from a "liquidity pool." A liquidity pool is a pot of crypto assets utilized to clear purchase and selling orders that appear. End users provide the assets rather than centralized liquidity providers.
How is KYC related to the Crypto Travel Rule?
KYC and the crypto Travel Rule are equally critical crypto compliance terminologies. KYC collects and transmits data on individuals and organizations that use an FI or VASP, Whereas the Travel Rule requires those FIs and VASPs to collect and transmit counterparty data. Learn how Notabene’s SafePII service leverages state-of-the-art cryptography to encrypt and store PII.
References:
Fletcher, Emma. 2022 | “Reports Show Scammers Cashing In on Crypto.” Consumer Protection: Data Spotlight.
Notabene is on a mission to make secure and trusted crypto transactions a part of the everyday economy. Using privacy-preserving technology, our end-to-end Travel Rule compliance software helps VASPs turn compliance into a competitive advantage.
Clients use our end-to-end Travel Rule compliance solution to identify virtual asset accounts, perform mandated VASP due diligence, and manage regulatory and counterparty risks from one holistic dashboard. Additionally, our powerful integrations from the marketplace allow clients to perform continuous transaction monitoring, an integral part of KYC measures.
Learn more about the messaging protocols that VASPs use to share customer information.
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