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KYC Crypto: What is KYC verification and why do cryptocurrency exchanges need it?

Know Your Customer (KYC) is a fundamental component of how financial sector companies prevent illicit criminal activities, and perform due diligence, for anti-money laundering (AML). When referencing cryptocurrency firms and exchanges, KYC can be a point of contention, due to customers favouring anonymity. However, it is critical that KYC processes in crypto are followed, to better secure transactions, increase public perception and trust, and prevent the growing trend of crypto-facilitated illicit criminal activities.

What does KYC in crypto look like?

Operating in anonymity is a fundamental tenet of cryptocurrency technology, and part of why it exploded in popularity. To this day, the identity of the creator of Bitcoin is not 100 per cent known, as Satoshi Nakamoto is said to be a pseudonym. Implementing KYC verification in cryptocurrency is understandably a contentious topic. However, through better capturing and analysing customer personal information by virtue of diligent KYC processes, a business can identify their risk exposure to money laundering,  and other illegal behaviour.

Let’s explore what KYC means for cryptocurrency firms and exchanges, particularly when decentralised services highly value anonymity.

What is KYC?

You may be asking yourself, what does KYC stand for, and what is KYC in crypto? KYC is an acronym for Know Your Customer or Know Your Client. It refers to a set of processes designed to better protect financial institutions and companies in the finance sector from the growing risk of corruption, fraud, money laundering, and terrorism financing.

It generally involves an established process of verifying customer identity, reviewing customer activities to ensure the source of their funds is secure, and ongoing assessment of illicit activity risk. KYC processes allow companies to perform high-quality and effective compliance and risk management and due diligence.

According to AUSTRAC, companies must apply some level of customer identification procedures to all customer onboarding, and it generally involves assessing the validity of a customer’s identity:

  • For individual customers this may mean collecting personal identification information or documents, such as their date of birth or residential address, or a recent bank statement or PAYG Summary.
  • For customers that aren’t individuals, this involves assuring the entity exists, whether through an Australian Business Number (ABN), Australian Company Number (ACN), or an Australian Registered Body Number (ARBN). You may also rely on documentation such as recent tax returns, superannuation membership and more.

What is the KYC process for cryptocurrency exchanges?

KYC’s meaning in crypto is all about cryptocurrency exchanges complying with KYC measures. These companies may consider implementing the following steps:

  1. Request Personally identifiable information (PII) in the onboarding process, including full name, date of birth and address.
  2. Verify this information against easily cross-checked, government-issued identification, such as a birth certificate, passport, drivers’ licence, a utility bill or a Tax File Number.
  3. Determine if the customer classifies as Politically Exposed Persons (PEP), utilising databases, third-party reports, sanctioned lists, and even social media. Cryptocurrency exchanges may want to consider registering for PEP specialist databases to speed up this process.

If you’re wondering what is KYC verification in crypto; only once a customer’s identity has been verified are they able to utilise the services of the exchange.

These are just some of the KYC processes a crypto exchange should consider adding to their onboarding process as part of AML compliance. In fact, solving KYC problems for crypto is an emerging market for startups. For example, Passbase raised over $13.5 million in initial funding by offering financial companies a KYC tool that lets clients swiftly verify customer identity through the aforementioned identification data. It even allows for easier verification by uploading a selfie.

Do you have to use KYC when buying crypto?

One of the greatest challenges facing Australian regulators is that, for an individual or an entity looking to buy crypto without verification, there are still avenues available for them to avoid KYC in a global market.

In fact, crypto compliance with KYC can be especially challenging for companies in the financial sector looking to do the right thing, as:

  • There is minimal regulation in comparison to traditional financial companies
  • Newer technologies are constantly rolled out, requiring individual KYC solutions, all of which can take time.
  • Decentralised channels operate globally, meaning AML compliance loopholes are always available, and customers seeking more relaxed KYC rules may find these overseas.

However, as laws and regulations steadily come up to date with crypto technology, it is likely to become harder for Australian crypto traders to get away with this. Even major crypto exchange, Binance, announced in 2021 it would be implementing identity verification processes due to its importance for the crypto space.

KYC obligations, as well as AML compliance, are compulsory for cryptocurrency exchanges in Australia, according to ASIC. Without KYC verification, a cryptocurrency exchange may be held liable if a customer commits a crime as this company failed its due diligence.

The pros and cons for KYC for Crypto

For crypto exchanges in Australia looking into implementing new or more thorough KYC obligations, it’s worth weighing up the benefits and disadvantages.

Pros of KYC for crypto:

Protection from liabilities – Utilising KYC processes allows you to meet compliance obligations with the Australian regulators, particularly around AML due diligence. If one or more of your customers are engaging in illicit activity, as facilitated through your exchange, you may be held liable.

Reduction in instances of money laundering and scams – Having more thorough KYC processes in place may help to reduce the rising instances of illegal activities, such as financial scams, fraud and money laundering.

Improved transparency and trust – The ability to verify customers may assist in new building customer trust, as it showcases a greater level of financial responsibility on the part of the exchange, and demonstrates greater protection of their accounts. This can be especially useful given the negative media surrounding the rise of crypto scams and its perceived safety as a high-risk investment option.

Downsides of KYC for crypto:

Customers may look elsewhere – Unfortunately, some customers that value the anonymity offered by truly decentralised exchanges, may look for alternative options outside of your company. That being said, you may ask yourself if businesses really want to engage with customers that are more likely to put you at risk and engage in illegal activities? 

Regulation to technology delay – In the evolving space of crypto, sometimes the regulations rolled out in Australia are months, even years, behind the latest innovative technology. This can make following KYC obligations more challenging.

What does the future look like for Crypto and KYC?         

It is expected that even the most reluctant of identity verification converts in the crypto exchange space will make the switch to enforcing KYC compliance. Not only will this help to reduce instances of illegal activity, but it is an easy way that exchanges can work to improve crypto’s public perception. Many people still doubt the safety of crypto as an investment option, particularly because of rising levels of scams and theft. By shifting to an environment of greater compliance, crypto may be able to increase public sentiment, resulting in greater uptake and adoption globally.

Further, regulators are now increasing requirements for the travel rule, which will become a significant factor companies will need to prioritise. Put simply, the ‘Travel Rule’ means that when crypto transactions worth over $1,000 are exchanged between two parties, the crypto service provider must communicate the PII of the sender of the funds to the crypto service provider of the receiver of said funds, and vice versa. This is the first globally implemented crypto regulation and may mean more global regulations become commonplace.

Finally, KYC may become an essential part of the Non-Fungible Token (NFT) space. Money launderers may easily utilise one or more NFT transactions to hide assets or disguise a money trail. It’s likely that KYC obligations will become just as fundamental for NFT marketplaces as they are for crypto exchanges.

If your financial services sector company is looking to implement KYC processes, or you want to better understand KYC/AML legislations, CreditorWatch has you covered. Our easy-to-use KYC reporting tools can do the hard work for you in assisting your crypto exchange in meeting AML compliance and KYC obligations.

You’ll gain a greater level of due diligence and better protect your business and its customers from fraudulent activity, all while meeting AUSTRAC obligations. Contact us today to find out how CreditorWatch can transform your KYC reporting.

Link to CW_1.01_High Risk Customers when published

crypto exchanges verification
Michael Pollack
Head of Media & Communications
Michael joined CreditorWatch in July 2021. He has more than 20 years’ experience in business journalism, marketing and communications strategy and digital content development. He is passionate about communicating to the business community how CreditorWatch’s product suite can help them grow and protect their companies.
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