cryptocurrency and kyc

Exploring the Link between Cryptocurrency and KYC: Why it Matters

Overview of Know Your Customer (KYC)

KYC being the first stage of Anti-Money Laundering is crucially important for the cryptocurrency exchanges. Since cryptocurrency is a seamless and intangible money and can be transacted at a fast rate, the risk of money-laundering greatly increases in it. KYC is a procedure for decentralized identification of customers. Financial Institutions can review and take actions for the customer's risk profile accordingly through the KYC.

What is KYC in Crypto?

Cryptocurrency has been a prime target to money laundering activities since its inception. KYC process can help the AML regulators to regulate the cryptocurrency for which they require the following basic approach:

  • Collet and confirm fully relevant, updated & required customer’s information
  • Monitor the activities closely and highlight any suspicious activity before time through efficient KYC and AML
  • Report the risky suspicious activities to the authorities

Benefits of KYC in Cryptocurrency

Apart from the drawbacks of implementing KYC, it has some potential benefits to the Cryptocurrency too.

Increased Trust of Customers

When users are confident in investing their money in safe & secure virtual assets through KYC, they will have more trust in the system.

Increased Transparency

Over the course of 2021 and 2022, over 46,000 individuals reported losing over $1 billion worth of cryptocurrency to scams and fraud. According to Fletcher (2022), implementing strong identity verification measures can significantly decrease fraudulent activity and enhance the reputation of the crypto market.

Reduced Money Laundering & Scams

As regulations continue to develop, having strong KYC processes in place will allow businesses to stay ahead of the game. These procedures allow VASPs (Virtual Asset Service Providers) to deter or minimize instances of false identity, prevent money laundering, and assess the risk level of their customers by requiring government-issued identification and evaluating financial history and assets. By implementing these measures, businesses can minimize legal and regulatory risks and focus more on improving conversion rates, speeding up transactions, and complying with regulations.

Increased Market Stability

The cryptocurrency market is known for its high level of volatility, often due to questionable, anonymous transactions. By implementing KYC programs that prioritize identity verification, the market can become more stable and experience growth in value.

The role of VASPs

VASPs are the Virtual Asset Service Providers who basically are the main workforce behind crypto exchanges. A VASP is any individual or entity that performs activities such as exchanging, holding, safeguarding, selling, converting, or transferring virtual assets (VAs) on behalf of other individuals or entities.

Mostly the VASPs are allowed to operate when they comply with a specific KYC approach to prevent fraud, money laundering and other Fincrime. It is a stepwise approach mentioned as follows:

  • Step 1: Customer’s Personally Identifiable Information (PII) is collected. It includes the personal details like name, d.o.b, address etc.
  • Step 2: Compare the collected information with the government's database and the government issued documents to find any discrepancies.
  • Step 3: Work on the Politically Exposed Persons (PEPs) database for information against the defaulters

Virtual currency like Crypto can be prevented from becoming a tool to money laundering by these basic steps which is a KYC approach itself.

How to Monitor Cryptocurrency Transactions?

Undeniably, cryptocurrency is becoming popular. Countries that previously were reluctant in regulating it are now moving towards legalizing & supporting the cryptocurrency at national level. In the US, SARs (Suspicious Activity Report) are submitted to the regulatory authorities and law enforcement agencies against any suspicious transaction in cryptocurrency. Another way for businesses to mitigate the risks associated with cryptocurrency transactions is to implement a compliance program using robust transaction monitoring software. While the complexity of cryptocurrencies can present technical challenges, innovative regulatory technology solutions can address these challenges. The greatest risk in the cryptocurrency industry is the lack of control and oversight over the movement of cryptocurrencies on blockchains.

The system that is efficient and effective enough to Monitor the Cryptocurrency shall have the following key attributes:

  • It should have the payment fraud intelligence system that can be customized to the needs of the regulatory bodies
  • Instant notifications & alerts system against any suspicious transactions via cryptocurrency and any other currency that is linked to the cryptocurrency
  • Time saving mechanism for the compliance teams
  • Cost effective and cost efficient automated risk scoring
  • Audit trail maintenance
  • Maintain accuracy in SARs
  • East information sharing
  • Instant transaction monitoring
  • Simulation in rules

Many firms provide the Virtual Asset Monitoring exchange services where they require tools for transaction monitoring. Some of these tools are Chainalysis, Elliptic, Crystal Blockchain, Coinfirm.

Risks in non-compliance to KYC while trading Cryptocurrency

Much riskier than before the KYC non-compliance in cryptocurrency trading can cause serious actions by the regulatory authorities. Virtual Assets can be bought without KYC but it poses serious threats including the threat of fraud, scams, hacking & others. However, It is possible to obtain virtual assets (VAs) without going through the KYC process. For example, crypto ATMs and decentralized exchanges (DEXs) do not require KYC. Crypto ATMs allow users to purchase cryptocurrency using cash or debit cards, while DEXs are peer-to-peer markets that use blockchain technology to facilitate large-scale trading of crypto assets. DEXs use automated algorithms rather than serving as financial intermediaries.

Regulatory risk in Crypto without KYC

A crypto platform might detect fraudulent transactions through fake accounts. This poses a threat to the virtual assets of users. Buying Virtual currencies without a KYC has this serious regulatory risk involved. Regulatory authorities such as OFAC have severely punished non-compliant cryptos. Similarly, exchanging crypto without KYC poses a serious risk too. Crypto Travel Rule is also applicable as the Financial Institutions & VASPs are required to collect their own and counter party’s data and transmit it.

Final Thoughts

KYC and the crypto Travel Rule are both important terms in the realm of cryptocurrency compliance. KYC involves collecting and sharing information about individuals and organizations that use financial institutions (FIs) or virtual asset service providers (VASPs), while the Travel Rule requires FIs and VASPs to collect and transmit data about their counterparts.

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