Everyone with a bank account is familiar with the Know Your Customer process where a financial institution such as a bank collects and verifies customer details to check the risk associated with a potential customer. But what about KYC in cryptocurrency trading platforms? Do they practice KYC regulations? If so, wouldn’t that be against the principles such exchanges were built on? What are the purposes of applying such norms on a platform that assures anonymity? Also, do all kinds of crypto exchanges exercise KYC norms? Keep reading to learn more.
What is KYC in Crypto?
Table Of Contents
KYC in crypto is a protocol centralized exchanges follow to verify the identities of their users. Unlike Decentralized Exchanges where the users are assured anonymity, centralized exchanges have KYC as a legal requirement complying with the Anti-Money Laundering (AML) measures and assessing customer risk. These measures are meant to protect customer interest as well as digital assets while ensuring the users’ privacy.
The KYC process collects basic but important information concerning an individual, including their data such as legal name and address, proof of the provided data with a government-issued ID, proof of date of birth, biometric data, and national ID number, before onboarding them. After the data-gathering process, these platforms verify the accuracy of these details corroborating with respective authorities to ensure the credibility and the level of risk each customer carries, based on which they are assigned a risk rating.
Although the customer will be given access to the platform after this one-time verification, the process does not end there. Know Your Customer is an ongoing process that requires constant monitoring and needs to be updated at regular intervals based on the risk rating assigned for each user. The protocol comes with its benefits and challenges, which you will learn in detail as you read further.
Benefits of KYC in Crypto
First, let us talk about the different ways in which the Know Your Customer Protocol benefits both the users and the trading exchanges.
Reduced risk of fraud and other illicit activities
Following KYC protocols is primarily meant to prevent fraudulent activities carried out on the platform. Such activities include money laundering and funding terrorism and could affect the reputation of the trading exchange. Assessing risk and restricting access to those who pose threats of these kinds of illicit activities is an effective way of ensuring security not just of the platform but of the nations.
Enhanced transparency and credibility
Practicing KYC norms gives the impression that a platform is serious about its financial dealings. Such an impression based on transparency increases the firm’s credibility, attracting more investors to the platform. It also enhances security for users as the verification process discourages scams and identity thefts that would otherwise be easier on a platform promoting anonymity.
Mitigate the risk of legal disputes
Compliance with KYC norms reduces the risk of legal disputes as it shows regulatory authorities that the exchange is committed to ensuring the safety and security of customers and the nation. Although the Know Your Customer norms of the crypto industry are neither finalized nor standardized, raising the bar with increased monitoring and adhering to existing regulations is a way of protecting the firm against potential lawsuits.
Increased stability of the online market
One of the major factors that contribute to the volatility of tokens is complete anonymity. With KYC regulations in practice, the exchanges will have all the necessary details about their users in hand, leading to a more stabilized market. A comparatively less volatile market will also reflect on the confidence level of potential users, attracting more investors to the platform.
Challenges of KYC in Crypto
Establishing KYC regulations in the crypto space is not as easy as it might seem. There are certain drawbacks and challenges like the ones listed below that make it difficult to put these norms into practice.
Violation of decentralization principles
Know Your Customer practices are in a way a violation of the decentralization principles that assure no centralized control over anyone’s data. This goes against the vision of cryptocurrencies and digital assets that are supposed to be free of the restrictions that conventional financial platforms or institutions are tied with.
Lack of anonymity and privacy
Although KYC does not take away privacy entirely, it cannot offer complete anonymity either. Some are concerned that valuable data including biometric details, photos, location, and such could be misused in many ways if breached. This data breach concerns that occur when sensitive personal information is collected by these platforms make certain groups of users hesitant to invest in assets traded on such exchanges.
Reduced accessibility and compliance fines
Enabling KYC practices on exchanges increases costs on both ends, The platform’s as well as the users’. This is one factor that restricts accessibility to the crypto space for many people. Similarly, with the assignment of risk rating, certain platforms might block users with highly speculated risk, which also limits access to an otherwise open space that is designed not to discriminate among users regardless of the factors that separate them in the real world. Certain platforms that fail to comply with the regulations as directed, end up paying compliance fines to authorities, also challenging the autonomy of the cryptocurrency world.
Fake IDs
Although KYC regulations are supposed to recognize and prevent fraud, scammers are aware of these techniques and have their methods to pass the verification, including fake IDs and deepfake videos. Such tools made with the help of AI make it impossible to identify real ones from fakes, defeating the purpose of the whole process.
Regulatory Impact
Know Your Customer norms in crypto have regulatory impact of various levels, both within the border and cross-border. Complying with the regulations provides crypto firms an opportunity to work within the legal frameworks established by the regulatory authorities of a country. Integrating this parallel, digital financial space into the mainstream system, although might not be appealing to a section of the investors, could benefit the community in significant ways.
Besides coordinating with the regulatory bodies within a nation, this process allows cross-border regulatory authorities to keep track of the data and prevent activities including money laundering and terrorism financing more effectively. This also takes the unfair advantage crypto spaces based in certain countries offer out of the equation by applying uniform standards for the industry globally.
As KYC norms allow the intervention of authorities into the crypto space, it helps them assess and manage the risk posed by the crypto space to the mainstream financial system. Also, with access to the identities of individuals holding digital assets, the government can enforce a tax on their earnings, which is not possible in a decentralized system.
Conclusion
Putting Know Your Customer norms into practice in the crypto space is a daring move considering the general sentiment toward such a decision from users who find it a haven just for the anonymity it offers. However, such a move comes with several benefits including a mitigated risk of illicit activities taking place on crypto exchanges misusing its privacy features, reduced risk of lawsuits with increased compliance with the government’s Anti-Money Laundering (AML) laws, decreased volatility of tokens, and enhanced transparency along with increased credibility among users and authorities.
Similarly, compliance with KYC norms also poses certain challenges including violation of privacy, data breach, and reduced anonymity. May perceive this decision as something that goes against the founding principles of the crypto space, which is built on decentralization and anonymity. The prevalence of fake IDs and limited accessibility due to increased cost and transaction fees are similar challenges that affect the smooth establishment of KYC in crypto. With that being said, governments globally are encouraging the practice of KYC in the crypto space, considering the ways it would benefit the mainstream financial system and the ease of managing the industry better than ever before.
