Understanding KYC in Crypto: How KYC for Crypto Works

KYC, or Know Your Customer, is a term that has been gaining recognition simultaneously with the growth of blockchain and crypto technologies. KYC was designed to help regulate the crypto market while also granting better privacy and security both to platforms and to regular users. 

But what exactly does it mean to be KYC-compliant, how does KYC work, and what are the consequences of skipping Know Your Customer compliance in the process of launching a new blockchain or crypto project? In this article, we will explain in detail the concept of KYC and everything else you should know to use it to your benefit.

What Is KYC and Why Is KYC Important for the Crypto Industry?

Before we can dive deeper into the cryptocurrency KYC process and tips for financial service providers required to do blockchain KYC verification, let’s find out what KYC actually is and why KYC requirements are now a standard part of due diligence for financial institutions.

KYC in the Context of Cryptocurrency

KYC, or Know Your Customer, is a set of rules and requirements for financial institutions to identify their customers. KYC procedures exist as part of Anti-Money Laundering laws and are aimed at determining which customers are more likely to be involved in various types of financial crime.

KYC requirements have been getting more and more attention lately due to the increased use of KYC in blockchain, but the truth is that this technology has been in use long before that. The origins of KYC date back to the 1970 U.S. Bank Secrecy Act (BSA), which introduced the concept of customer due diligence (CDD). CDD was designed to enable financial transparency and prevent money laundering. However, the first established KYC guidelines were introduced in the 1990s by the Bank of England. During the 1990s, KYC and related regulations gained even more significance, as now they were dealing not only with money laundering, but also with terrorist financing. However, it wasn’t until October of 2001, when the USA Patriot Act was enacted, that KYC measures became compulsory for financial organizations.

Which Financial Solutions Require KYC?

Although in this article we focus on the relationship between cryptocurrencies and Know Your Customer requirements, crypto firms are not the only ones who have to verify the identity of their customers with the help of KYC practices. Here is the definitive list of businesses that have to perform KYC checks:

• Cryptocurrency platforms
• Banking services
• Investment services
• Payment solutions
• Insurance platforms
• P2P lending and crowdfunding platforms
• Real estate platforms
• Tax services
• Online gaming and gambling platforms
• Precious metal and high-value asset providers

The Importance of KYC Compliance for Crypto Exchanges

While there are all kinds of financial institutions that need to perform KYC due diligence, there are several reasons why this type of compliance is especially vital for cryptocurrency exchanges. First, as these platforms are getting more and more common, they need to work on establishing a strong reputation in the industry, thus gaining a competitive advantage. Second, crypto platforms typically deal with large amounts of money, which can sometimes be linked to money laundering, terrorist financing, and other illicit activities. Third, completely anonymous crypto platforms offer far less protection against fraud to their users, which inevitably impacts the trust users put in the platform.

How KYC Helps Combat Criminal Activities

The reason why the fintech world is so invested in KYC cryptocurrency regulations right now is that they help deal with a range of illicit financial activities. But how exactly does KYC impact the safety of the online crypto industry? Here are a few examples of how it helps maintain a secure financial environment:

• Identity verification. With the help of KYC, platforms can know for a fact that their users are who they say they are, which makes it harder for criminals to use fake identities.
• Transaction traceability. Any transaction can be traced back to the individual who conducted it, complete with their personal information, lowering the risk of illegal activities.
• Fraud detection. Platforms are able to quickly identify users who have committed financial fraud before, limiting their possibilities regarding transactions or suspending them completely.
• Money laundering and terrorist financing prevention. By creating and growing the database of crypto users, the industry can jointly decrease activities like money laundering and terrorist financing.

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How Does KYC Work?

Know Your Customer is a set of rules and measures designed to improve and strengthen the crypto market. However, it only reaches its maximum efficiency when the KYC process is properly managed and planned. From the moment the customer first makes contact with the platform through their first completed transaction to the regular monitoring and reporting of unusual user activity to the authorities, the work of KYC is a vital component in ensuring the stability and security of the cryptocurrency industry.

Steps Involved in the KYC Verification Process

Building an efficient crypto KYC process is the most effective way to ensure the security and integrity of blockchain trading. But which steps are included in the process for crypto compliance, and what do organizations need to do to ensure compliance with Know Your Customer requirements? These are the five essential phases of the process.

1. Data Collection

The first step in the KYC process is collecting all the required data from the user. The list typically includes the following items:

• Full name
• Date of birth
• Home address
• Phone number
• Email address

In addition to that, many organizations require their users to provide additional documents: most commonly, it can be a copy of the government ID or a driver’s license. In some cases, a recent utility bill or a bank statement may also be required to allow users to use crypto capabilities.

2. Identity Verification

Once all required data is corrected, the platform then needs to make sure that the data provided actually belongs to the customer who provided it. Typically, this will be done by running the user’s documents through the government databases to verify their authenticity. Some platforms are also using advanced KYC software solutions that perform biometric authentication: for example, facial recognition to make sure that the photo in the ID matches the user’s face.

3. Risk Assessment

With the user’s data verified, the organization then needs to perform a risk assessment and find out whether the user poses any threats to the security of the platform. The most common factors taken into account here are the user’s geographical location, background, and financial history. While the latter is perfectly understandable when it comes to transaction security, the first two can be more nuanced. Using them, platforms can require users from certain locations or with certain backgrounds to pass enhanced due diligence, or impose limitations on their financial operations.

4. Ongoing Monitoring

At a glance, KYC may seem like a one-and-done event: as long as the user passes the initial check, they should be allowed free and unlimited access to the crypto space. However, KYC works best when it’s a continuous process aimed at maintaining a safe trading environment for everyone. Specifically, the platform may want to keep track of user transactions and surrounding conditions, taking actions and performing checks in case of large one-time transactions, multiple smaller transactions between the same users, or unusual activity from a certain geographic location.

5. Reporting and Record Maintenance

As part of the KYC compliance process, platforms may need to report KYC-related information and activities to the regulator. This usually includes customer identification documents, any communication regarding the verification process, and information regarding transactions. These records need to be stored securely and be easily accessible for external checks. Moreover, the platform may be required to report suspicious user activity to the authorities.

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What are the Benefits of Using KYC in Crypto Transactions?

KYC and AML checks require time and effort, both for implementing them and overseeing their completion. However, the benefits of KYC and identity verification for crypto services are too significant to ignore. Here is why crypto exchanges should adopt KYC programs.

Improved Security for Financial Institutions

With effective KYC measures in place, organizations can make it harder than ever for scammers to create fake accounts or use other illicit methods of obtaining financial services. Moreover, KYC is important for protecting the existing customers of crypto companies, ensuring the security of their accounts and making it nearly impossible to gain unauthorized access to existing user profiles.

Spotless Reputation of Crypto Platforms

The competition in the crypto and blockchain market is growing stiffer by the minute, and any up-and-coming or established cryptocurrency exchange needs to constantly work on attracting and retaining customers. Robust KYC measures in place enhance the security of the service, positively impacting the company’s reputation. Moreover, a service with a good reputation can collaborate with other companies more easily, expanding its reach and attracting new loyal customers.

All-Around Regulatory Compliance

Many crypto businesses are available globally, and with the growing number of opportunities to expand a crypto business, owners should also care about making their services legal under any jurisdiction. KYC remains an integral part of laws and regulations concerning crypto and other financial services. Being compliant with KYC, AML, and CTF (Counter-Terrorist Financing) regulations allows the business to expand globally with confidence.

Lower Risk of Illegal Activities

KYC helps the crypto market prevent illicit activities from taking place on the platform, and this is the number one reason why so many crypto exchanges invest in implementing robust KYC measures in the first place. Not only does the right KYC program make it more difficult for fraudsters to use the platform for their activities, but the fact that any suspicious transaction can be traced back to the perpetrator also helps immensely.

Higher User Accountability

Creating and maintaining detailed user profiles increases the accountability among users, as they are well aware of the fact that their personal information is known to the platform owners and stored there for future use. This encourages users to self-regulate their behavior to avoid lengthy checks or account restrictions. Moreover, the usage of KYC for crypto exchanges allows the platform to resolve conflicts faster and more efficiently, since all needed information, including private user data, is easily accessible. 

Differentiated Approach to Crypto Users

As blockchain KYC verification is getting more and more prevalent, service providers find new ways to serve their customers better with the help of KYC. Specifically, completing KYC verification can have certain perks not just to the crypto platform, but also to its users. For example, a crypto platform can make certain services only available to users who have verified their identity. This can range from lending and withdrawal limits to participating in exclusive token sales.

Steadily Maintained Market Integrity

In addition to helping maintain the security and integrity of a specific platform, KYC blockchain regulations also positively impact the rest of the market. Conducting in-depth user verification significantly lowers the chance of users manipulating the platform, the data and the transactions to create faulty activity that disrupts the market. The more crypto service providers make KYC checks mandatory, the more the market is going to benefit from it.

Can You Buy Crypto Without KYC?

From the moment blockchain crypto platforms started gaining popularity, one of their most appealing aspects was a certain degree of anonymity. But with the growing number of platforms that enforce and implement KYC requirements, is it still the case? Yes, even though most crypto exchanges require their users to undergo some sort of verification, it is still possible to buy cryptocurrency without KYC. The available options include:

• P2P (Peer-to-Peer) Marketplaces, where crypto is traded between users directly without any involvement from the platform.
• Decentralized Exchanges (DEX), platforms that function without a centralized authority, allowing direct exchanges between users.
• Bitcoin ATMs, which typically allow the purchase of small amounts of cryptocurrency with cash without requiring KYC verification.
• Non-KYC-Compliant Centralized Exchanges, a small group of platforms that still offer crypto services without adhering to KYC standards, although those are becoming more rare.
• Gift Cards and Vouchers, which are offered by some crypto exchanges, can be bought with cash or, in many cases, anonymously online.

How KYC Compliance is Regulated Globally

Currently, the US generates the highest revenue from cryptocurrency trade around the world, but the rest of the planet is catching up, and crypto demonstrates a tendency for growth in pretty much any locality. Naturally, with the increased rate of exchanging and purchasing crypto, the role of KYC becomes even more vital, and not just in the US, but also in other countries. Here are a few examples of how various regions implement KYC practices.

European Union

In the EU, KYC and AML requirements are imposed by the Anti-Money Laundering Directives (AMLD). Specifically, the 5th and 6th AMLD introduce stringent requirements for cryptocurrency exchanges and wallets. Among other things, AMLDs specify the criminal liabilities and increased penalties for failing to comply with the requirements.

United Kingdom

The United Kingdom governs the crypto industry mainly with the help of the Money Laundering, Terrorist Financing, and Transfer of Funds Regulations of 2017. The Financial Conduct Authority is the main governing body when it comes to KYC compliance in the UK. Additionally, the post-Brexit UK has retained many of the regulations that first came into place when the UK was part of the EU.

Canada

Canada’s KYC regulations are governed by the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA), which requires financial institutions, including crypto platforms, to implement KYC and AML measures. 2021’s amendments to the PCMLTFA extended the regulations to virtual currency businesses, which include every crypto platform operating in the country.

Australia

The Anti-Money Laundering and Counter-Terrorism Financing Act 2006 governs the KYC and AML regulations in Australia. Under the AML/CTF Act, organizations are required to verify user identities, maintain records of customer accounts, and monitor transactions for any suspicious activities taking place. The Australian Transaction Reports and Analysis Centre (AUSTRAC) is the regulatory body overseeing compliance with KYC.

Japan

Japan’s KYC regulations are detailed in the Act on Prevention of Transfer of Criminal Proceeds. Under this act, financial institutions, including cryptocurrency exchanges, are required to keep detailed records of user accounts and transactions, alerting the authorities to anything that falls outside of the legal transaction and usage realm. The Financial Services Agency (FSA) is the regulatory body that oversees and governs KYC compliance in Japan.

India

India’s regulatory stance on crypto and blockchain has been lacking certainty, but KYC compliance is the one aspect of crypto trading that India has embraced. The Prevention of Money Laundering Act is the legislation that regulates the implementation of KYC requirements and reporting practices for compliant businesses. The regulatory process is overseen by the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI).

United Arab Emirates

In the UAE, KYC compliance is overseen by the UAE Central Bank and the Financial Intelligence Unit. KYC requirements are also outlined in the legislation concerning the regulation of stored values and electronic payment systems. Moreover, the Abu Dhabi Global Market (ADGM) and Dubai International Financial Centre (DIFC) have developed their own sets of policies that closely align with the world’s best practices on KYC regulations.

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Consequences of Failing to Comply with KYC Regulations

Robust KYC policies help crypto platforms and financial institutions offer secure services to all customers. However, it’s not exactly uncommon for companies to either treat KYC crypto regulations like an afterthought or skip these preparations completely because they require a significant amount of resources for implementation. Safe to say, that is always a mistake. KYC is vital for financial operations, and here are the potential consequences of failing to comply with these requirements.

1. Reputational Damages

As users, especially experienced crypto traders or organizations, are getting more and more aware of the impact of KYC compliance on the security of online payments, they are not going to tolerate services that skip KYC any longer. Plus, failure to comply with Know Your Customer requirements often results in a lot of negative media coverage, which not only further discourages existing customers from continuing to use the platform, but also prevents new users from signing up and trusting the service with their data.

2. Legal Penalties

Failure to comply with KYC requirements can lead to a variety of legal consequences for the company and its key workers. The most common type of consequence is a fine, which can be the result of a breach or an audit that discovered the lack of compliance with KYC. In some cases, fines can reach 10% of the company’s annual turnover. 

Another widespread form of legal consequence for flawed KYC management is a civil lawsuit, which can be filed by customers or stakeholders. Finally, criminal charges against the company’s executives or employees are possibly the most severe legal consequences there can be. Criminal charges can be pressed in case of a major breach resulting in financial losses or when the lack of compliance has led to money laundering, terrorist financing, or other equally dangerous outcomes.

3. License Suspension

Registration and an operating license are usually required from all financial software solutions, including crypto wallets and exchange platforms. Companies can also lose their license and registration if they fail to comply with KYC requirements and their shortcomings are discovered by the corresponding regulatory body, which can depend on jurisdiction. Since the company will no longer be able to operate legally without a license, the suspension of the license and the cancellation of the registration will lead to financial and reputational losses of its own.

4. Intense Monitoring

A crypto platform that has already been found to break KYC rules by the authorities is guaranteed to be scrutinized and intensely monitored in the future. Frequent audits, detailed inspections, and ongoing monitoring of the company’s activities are bound to happen. Additionally, the company may face the need to provide in-depth reports more frequently than companies with a clear reputation have to do. All of this can be time-consuming and costly, not to mention the subsequent reputation damage.

5. Regulatory Sanctions

Failing to comply with KYC regulations may have not only momentary consequences, but also impact the company’s operations in the long run. Specifically, the authorities may refuse to grant licenses for additional financial services, while foreign markets may also stop the company from expanding globally if there have been known violations of KYC requirements. This negatively impacts the organization’s ability to scale and expand, as well as puts additional strain due to having to overhaul KYC systems, implement stricter compliance protocols, and retrain staff to avoid repercussions in the future.

6. Increased Risk of Fraud

Ignoring KYC requirements or doing a half-hearted job of implementing and monitoring them puts the organization at an increased risk of fraud. This includes both fraud committed by scammers against other users of the platform and fraud committed against the organization itself. The most obvious consequence of this is financial losses and reputation damage. However, if the organization is found complicit in crimes like money laundering and terrorist financing, severe legal consequences are nearly bound to happen.

7. Impact on Business Deals

As the financial industry is constantly moving forward, crypto platforms and wallets are frequently going through acquisitions, mergers, and other corporate restructuring activities that benefit everyone in the end. However, knowingly failing to comply with KYC regulations puts the organization at risk of dropping out of mergers or acquisitions due to potential buyers or investors no longer seeing enough value in the business move. Lost opportunities and financial losses, as well as the market changing their assessment of the company, are the inevitable consequences here.

Solutions in the KYC for Crypto Market

As the role of Know Your Customer regulations in creating a safe crypto landscape is increasing, and as regulatory bodies are tightening their stance on companies not complying with the requirements, there is now an emerging wave of crypto KYC solutions. These solutions leverage innovative technologies, including biometrics, AI, and blockchain to conduct KYC checks more efficiently and assist companies with management and reporting.

Which Blockchain KYC Solutions Are Available Today?

Several solutions are available for ensuring compliance with KYC in cryptocurrency and blockchain. Let’s take a closer look at the most popular solutions and their uses.

1. Veriff

Veriff is a popular choice for KYC processes in various industries, including fintech, crypto, and online services. This solution offers AI and machine learning to conduct identity verification by analyzing the provided documents and biometric data. Veriff’s KYC solution is designed to detect fraud, ensure compliance with AML regulations, and streamline the onboarding process, making it a secure and user-friendly option for companies of all sizes.

2. Shyft Network

Shyft Network is a blockchain-based identity verification platform designed to ensure secure and KYC-compliant financial processes. It provides an accessible opportunity for secure sharing of verified identity data across different networks, helping companies guarantee KYC compliance even in foreign markets. Shyft Network’s decentralized approach enables data sharing with a focus on privacy, helping companies strengthen their compliance frameworks without worrying about data integrity.

3. Persona

Persona is a handy identity verification platform whose standout feature is the robust customization opportunities it provides. The available solutions for ensuring KYC compliance include tools for document verification, biometric authentication, and risk assessment. In addition to KYC compliance, Personal also supports a number of other regulatory requirements, including GDPR, making it a solid option for releasing crypto software on a global scale.

4. Civic

Civic is a decentralized identity verification platform that streamlines the KYC process by enabling users to create and manage digital identities. Civic’s KYC solution allows users to share their verified identity information with service providers without exposing more of their data than needed. The platform is designed to enhance privacy, reduce fraud, and simplify compliance with AML regulations, making it a valuable tool for businesses in the crypto and fintech industries.

5. Jumio

Jumio offers an AI-powered identity verification solution that simplifies the KYC process by combining document verification, facial recognition, and other biometric data. It is employed across various industries, including finance and crypto platforms, to ensure compliance with AML regulations. Jumio’s KYC platform is designed for real-time verification, helping businesses onboard customers quickly and securely while minimizing the risk of fraud.

6. uPort

uPort is a decentralized identity platform built on the Ethereum blockchain, offering a KYC solution that allows users to securely manage and share their digital identities. By giving users full control over which identity data they want to share and when, uPort supports privacy-focused KYC processes that comply with global regulations. The platform’s decentralized nature makes it particularly suitable for blockchain-based services and applications that require secure identity verification.

7. Chainalysis

Chainalysis provides a suite of blockchain analytics tools, including KYT (Know Your Transaction), which enhances KYC processes by monitoring and analyzing cryptocurrency transactions for suspicious activity. While Chainalysis is not a traditional KYC platform, it nevertheless supports AML compliance by helping businesses identify high-risk transactions and customers. It’s widely used by cryptocurrency exchanges and financial institutions to ensure compliance with global regulatory standards.

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How to Choose the Most Suitable Crypto KYC Solution

With no shortage of crypto and blockchain KYC solutions in the market, making the right choice is often more of a challenge than many realize. In order to build a solid cryptocurrency KYC process at your organization, your solution of choice must meet certain criteria. Here are the things to look for in crypto KYC solutions:

• Regulatory compliance. The tool you choose must be compliant with all relevant regulatory requirements, including AML, GDPR, and others, depending on the jurisdiction.
• User experience. Don’t make KYC verification a hurdle for your users — opt for a solution that offers a user-friendly interface and a minimum of steps needed for verification.
• Customization. You should be able to tailor your KYC solution to your specific business needs and risk management policies without a lengthy development process.
• Security. For a product from the security sector, its own security capabilities matter even more. Look for a solution that offers strong encryption, secure data storage, and robust access controls
• Scalability. Choose a solution that provides diverse scalability opportunities, allowing it to grow alongside your business and support an increased number of users and transactions.
• Integration capabilities. Make sure the solution can be easily integrated with your core system, as well as other tools you are using in your work.
• Company reputation. Before you make the choice, research the solution provider online to find out what users think about it and whether its track record supports its trustworthiness and security.
• Training and support. To help your team effectively and quickly implement the solution, the provider needs to offer at least some onboarding and training, as well as ongoing support.
• Cost. Ensure that the solution you choose is within your budget; pay attention not just to the upfront cost, but also to the maintenance, licensing, and other ongoing fees.

The Future of KYC in Cryptocurrency and Emerging Technologies

The use of KYC in blockchain and crypto is getting more advanced, and so do the technologies that go into developing these solutions. Every year, we are witnessing new trends that dictate the way KYC is implemented and monitored, and these are the most noteworthy trends for 2024.

1. Artificial Intelligence

AI and ML are two technologies widely used to automate and enhance KYC processes. They can be very helpful in identifying patterns, detecting abnormal behavior, and increasing the accuracy of identity verification — among other things, by reducing the number of false positives and minimizing the team’s reliance on manual verification methods.

2. Biometric Identification

Fraudsters are using increasingly sophisticated techniques to scam users and platforms, and the use of biometrics is one of the ways the industry is trying to combat that. Involving biometric data, such as fingerprints, facial recognition, and voice recognition, is gaining popularity as the solution for preventing scammers from employing fake identities.

3. Blockchain

Blockchain is used for decentralizing identity verification systems, creating secure data storage that is protected against tampering and stealing. Moreover, KYC blockchain solutions give users better control over the use of their data, allowing them to store it individually and share it with organizations when and where they need it.

4. RegTech Solutions

Regulatory technology is gaining momentum as a solution allowing companies to comply with AML and KYC requirements even more effectively. RegTech combines advanced analytics, cloud-based capabilities, and automation mechanisms to streamline compliance processes and reduce the cost of achieving KYC compliance.

5. Big Data Analytics

Using big data in the process of KYC complaints allows companies to gain valuable insights by automatically processing vast amounts of user data. Big data analytics help identify trends, detect unusual activities, perform risk assessment, and predict the possibility of fraud, as well as create more detailed user profiles and make better-informed decisions.

6. Enhanced Customer Due Diligence

Customer due diligence (CDD) is a standard part of ensuring KYC compliance for a crypto platform. However, the increased fraud risks have led to enhanced CDD practices being implemented. Using a variety of tools and techniques, companies can now identify high-risk customers and monitor their activities more closely.

7. Global KYC Solutions

Since crypto and blockchain businesses are rarely confined to just one location and strive for global presence, the task of complying with KYC requirements becomes both more imminent and more challenging, as now there is more than one possible jurisdiction to care about. Global KYC solutions like Civic, Persona, and Shyft Network simplify and speed up the task of international compliance.

8. Self-Sovereign Identity

The self-sovereign identity technology gives the personal information ownership and control rights back to the users. Only when the user decides to share their data with service providers, can they do so, and only the data that is absolutely required. This offers greater privacy and security to users while increasing the trust between customers and organizations.

Final Thoughts

If you are in any way professionally involved in running a crypto exchange, then you already know that KYC compliance is not just an option to consider — it’s a progressively more important component of the blockchain and crypto market, helping keep things secure and low-risk both for platforms and for their customers. This is why, right now, it’s a question of how to comply with Know Your Customer requirements as effectively and easily as possible, and we hope that our guide has given you the knowledge and tools it takes to succeed in this crucial area.