01 September 2022 • 6 min read
If the current crypto market downturn has given you a case of the crypto winter blues, then some interesting statistics might cheer you up. Approximately 300+ million people around the world use and/or own cryptocurrencies as of 2021; the global crypto market cap is $2.17 trillion as of 17 December 2021; and approximately $112 billion is traded in cryptocurrency each day.
With such impressive stats, it is unsurprising that many people are being drawn to the exciting new world of cryptocurrencies and blockchain technology. However, the influx of newbies also brings with it plenty of novices who might not be familiar with all the terms and specialized lingo commonly used in the space.
You might have heard of “FOMO” (fear of missing out), for example, but what does KYC mean? In the following article, we’ll tackle the ins and outs of KYC, taking a closer look at what KYC really means, why it's important, how it works, its many benefits, and why (and how) some people decide to trade crypto without undergoing a KYC check.
In the world of cryptocurrency, and financial services more generally, the acronym "KYC" stands for "Know Your Customer” and involves verifying an individual’s identity before entering into a business relationship with them. “KYC” isn’t that new a term, as it has been used in financial institutions, banks, and other businesses to verify customers' identities.
While the KYC process can be time-consuming and expensive for businesses, especially if they have many customers, it is an important part of compliance and helps to protect businesses from financial crime.
A KYC check can be conducted in a variety of ways, but typically businesses will ask customers for identity documents, such as a passport or driver's license. The customer's identity will then be verified against relevant databases. Depending on the business, additional information might be required from the customer, such as proof of address, income, or selfie-based identification.
Binance’s basic KYC procedure, for example, consists of three steps: customer identification, customer due diligence, and ongoing monitoring. As with many centralized exchanges, they require personal information, a government-issued ID, and facial recognition to complete the initial verification process, but then continue to oversee a user’s information to ensure that it is up to date.
A form of due diligence, KYC is part of a broader vetting process that can include anti-money laundering (AML) controls in order to gauge risk and the possibility of fraud. As we’ve seen already, in the case of crypto, a decentralized exchange such as Binance will ask a trader to submit personal data to verify the trader’s identity and, if approved, continue to monitor the trader’s transactions for any hint of suspicious activities.
There are a few key reasons why crypto exchanges require KYC. First and foremost, it helps exchanges prevent fraud by ensuring their users are who they say they are. For instance, a hacker could try to use fake credentials to get into an exchange, but, if the exchange has already verified its users through KYC, then they're less likely to be fooled by a scammer trying to steal your personal information and identity.
It also helps to prevent money laundering. By having customers submit KYC information, exchanges can verify identities and make sure that traders are not using stolen funds or assets or engaging in other illegal activity. Additionally, KYC compliance helps exchanges meet their legal obligations. In many countries, financial institutions must collect KYC information from their customers to comply with anti-money laundering (AML) regulations, which require them to prevent transactions from being used in criminal activities
Another reason crypto exchanges require KYC is to defend against terrorism financing. By knowing who their customers are, crypto exchanges can help to prevent terrorist groups from using cryptocurrencies to finance their activities. In the wake of 9/11, the US government enacted a series of laws designed to prevent terrorist organizations from financing their activities, with one of them being the USA PATRIOT Act. This law also applies to crypto exchanges, which are required to collect KYC information from their users.
Finally, collecting KYC information can help exchanges provide a better customer experience. For example, an exchange can offer features like personalized customer support or targeted marketing communications by knowing their customer's identity. Overall, requiring KYC is good for both crypto exchanges and their customers. It helps to prevent fraud and money laundering, comply with regulations, and improve the customer experience.
Although cryptocurrencies have been largely driven by anonymity ever since their inception, there is a growing need to adapt to KYC regulations in the wake of their increased popularity. This has led to strong KYC policies being enforced by many crypto trading exchanges worldwide to be fully compliant with AML and KYC regulations. Some, however, find such requirements and subsequent monitoring intrusive, which is precisely why such traders choose to use crypto exchanges without KYC.
Typically, KYC-averse traders will opt for exchanges that do not require such protocols for one or a combination of reasons.
It is not uncommon for some users to believe that identity verification is contrary to the concept of cryptocurrency.
Making use of KYC also carries risks: access to your data can be compromised; third parties can access your data; and data that has been leaked or stolen can be used to steal your cryptocurrency (phishing).
It may be in the interest of some people to avoid screening related to sanctions, embargoes, PEPs, or SDNs.
Some might be interested in tax evasion.
Underage individuals might be looking to trade cryptocurrencies, but cannot meet age-related threshold(s).
While KYC requirements necessarily involve operational changes and challenges, crypto exchanges and users can still gain substantial benefits through compliance.
Below are some of the benefits of KYC.
The identification process is the first step in preventing fraud and money laundering. Only when a customer’s identity is verified can he or she trade on an exchange. This is particularly important in a regulatory environment in which exchanges must comply with know-your-customer (KYC) laws.
When an exchange has robust compliance measures in place, it can demonstrate to its investors that it is doing everything possible to protect them from theft and fraud. This helps to reduce the risk of being hacked or subjected to market manipulation.
Regulators are becoming increasingly strict about what types of organizations they do business with, so having an established track record of transparent, consistent regulatory compliance is essential for any company seeking access to these markets.
By verifying user identities, exchanges can improve transparency and build customer trust. Quite simply, customers are more likely to continue using a given crypto exchange if they know that it takes proactive steps to protect their accounts.
KYC is important because it helps protect the exchanges themselves from being hacked or scammed by hackers or scammers who want access without having any security clearances. And improved security protects the exchange itself. Without it, the exchange might be legally liable should a crime occur as a result of a lack of due diligence on their part.
Verifying user identities can help attract new customers by providing them with peace of mind about their account security and preventing fraud. Referral programs can also be used by exchanges in which they tout their reputation as an industry leader.
If you have many users maintaining separate accounts, verifying each can be time-consuming and costly. Verifying everyone at once can reduce costs by eliminating duplicate support queries, reducing customer service calls, and improving efficiency overall.
By implementing KYC policies, companies are better equipped to adapt to evolving legal expectations, improve transaction conversion rates, streamline processes, and ensure compliance with national and international regulations. As a result of demonstrating their compliance with KYC standards, these companies can reduce the risk of legal challenges and regulatory fines.
KYC is used to prevent the financing of terrorism. As KYC encourages AML/CTF compliance, meaning that exchanges must keep track of their users' identities and transactions. The most important part of KYC is verifying personal details such as addresses, phone numbers, and e-mail addresses. This information allows exchanges to verify whether particular people should be allowed to use the platforms or not.
It is a fact of life that crypto markets are notorious for their volatility, in part because anonymous transactions are often suspicious. By reducing fraud and other misuses of cryptocurrencies and cryptocurrency exchanges, the KYC process can make the crypto market more stable and profitable in the long run.
In this article, we've explained the KYC process and why it is so important for exchanges to have in place, both for their sake and that of their users. However, critics raise legitimate issues in terms of anonymity and decentralization, which KYC obviates. We've also highlighted how to trade cryptocurrencies without having to go through a KYC process and some of the reasons why traders might wish to do so.
The cryptocurrency industry is working hard to eliminate money launderers, scammers, and generally bad eggs. There are still bad actors, but overall this is a growing community that is trying to uphold high standards and, in the end, protect individual investors and crypto exchanges alike.
Whichever position you ultimately take, we can all agree that a measure of KYC within the crypto industry is both positive and necessary for the ecosystem’s overall health, legitimacy, and long-term viability.