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KYC and AML checks have been an integral part of financial institutions for a while now. As required by several financial regulators across the world, these mandatory checks have helped curb identity fraud cases and other financial crimes.
KYC and AML checks have targeted the traditional financial industry. However, with the introduction and growth of the crypto industry, issues arose on whether to include these checks. The main point of concern was that cryptocurrencies were unregulated. Today, however, several exchanges comply with the various KYC and AML regulations put in place. But the question remains, how have these checks impacted the crypto industry? In this article, we will delve into all the details that you need to know. But first, what is KYC?
Know Your Customer or KYC refers to a set of compliance processes that financial institutions and other companies use to obtain sensitive credentials from any new customers coming into the firm. These credentials help companies to verify a customer’s authenticity and prevent money laundering, terrorism funding, and other criminal activities from the business relationship.
The KYC check in the traditional finance industry, for example, requires that new customers provide identification documents before they can open a bank account.
KYC checks are categorized into two primary categories. These are Customer Due Diligence and Enhanced Customer Due Diligence. CDD is the necessary procedure to authenticate new clients. ECDD, on the other hand, provides additional checks for high-risk clients through further profiling and questioning.
KYC Checks and the Crypto Industry
During the earlier years of cryptocurrency, no one knew much about the industry. Cryptocurrencies were mostly unregulated because most financial regulators didn’t know what measures to put in place. For some crypto enthusiasts, this was an excellent characteristic of the industry as it helped maintain anonymity. The anonymity, together with the digital currencies’ decentralized nature, made the entire industry lucrative for some of the key decision-makers in the crypto space.
However, as the crypto industry grew and gained popularity, financial regulators began shifting their focus into the industry. And thus, the conflict arose since privacy has always been a central focus for the crypto industry.
A common misconception is that KYC checks challenge the decentralized nature of digital currencies. Although KYC is primarily offered to and for centralized institutions, the tests don’t make cryptocurrencies centralized through the monitoring. Instead, KYC checks help track transactions on the blockchain, allowing cryptos’ legitimate use as fiat currencies.
Processes for Crypto Exchanges
It is worth mentioning that the KYC checks for crypto exchanges are not entirely similar to those for traditional financial institutions. The primary difference between the two is that crypto exchanges conduct their KYC checks after a user is already signed up.
Not all exchanges carry out KYC checks. Most of them use a tiered system that requires every user to provide some additional information before they can deposit or withdraw large amounts of digital assets. Here are some of the processes that crypto exchanges use:
- No KYC – users can sign up for an exchange without completing any checks. They are, however, limited to certain functionalities such as no withdrawals.
- Basic KYC – users must upload some identification documents such as an ID and a photo. They also get fixed deposit and withdrawal limits.
- Full KYC – users have to complete an entire verification before they can deposit or withdraw large sums of digital assets.
Significance of KYC Checks to the Crypto Industry
One of the most significant impacts that KYC checks have had in the crypto industry is ICOs/IEOs/STOs. The rise of ICO offerings increased the number of fraud-related incidences in the crypto industry. Therefore, one of the KYC regulations in place is that investors in the US have been banned from ICOs.
ICOs, therefore, need to verify the location of their investors to avoid dire consequences with financial regulations.
Crypto exchanges have to comply with the checks, even more than ICOs have to. Exchanges that mainly accept fiat currencies have to report their transactions extensively, in line with regulatory compliance. Exchanges that only handle crypto transactions have fewer regulations in place.
It is worth mentioning that KYC and AML checks will vary, depending on an exchange’s base country. However, almost all states have measures to ensure that investors getting into the crypto industry are clean dealers.
KYC in the crypto industry has helped bring more investors on board. Some of the investors who were skeptical of the industry now find it easier to invest in digital currencies. On the other hand, these checks have put smaller companies at crossroads.
Picture this. A small company that handles crypto transactions is required to collect and store critical information about its customers. If the company doesn’t have proper security measures, its data is at risk, seeing as any hacker could gain access to it. Therefore, asking such a company to carry out KYC checks would be putting investors’ information at risk, which could, in turn, drive them away.
KYC checks in the crypto industry are like a double-edged sword. On the one hand, these checks help maintain digital assets’ security and safety in a space where anonymity and ambiguity are essential. On the other, they provide restrictions to investors and put their information at risk.
However, we cannot deny that KYC checks can improve the crypto industry and contribute significantly to these mass adoption currencies. However, key players in the crypto space will have to develop ways to ensure investors and clients are screened while maintaining their anonymity and decentralization of the industry.