The know your customer (KYC) process is an integral part of the financial industry and remains known as a crucial measure for anti-money laundering (AML) and counter-financing of terrorism. Due to this importance, KYC has also become a crucial aspect of the cryptocurrency industry.
But precisely what is KYC in crypto trading? Is crypto KYC safe in the first place? And how do you pass KYC for cryptocurrency institutions? To help you find an answer to these questions, there is a guide to KYC in the cryptocurrency sector.
What Is KYC Verification?
Anyone interested in the financial sector would want to know what KYC verification is all about and why it matters in the world of finance. “What is KYC verification”, it is a fascinating question to ask. It is quite important to genuinely dive into this question and to have a proper answer.
KYC refers to customer identification and verification of that customer. Note that there are KYC and eKYC that are present. The first is to know your customer, while the other is e-know your customer processes. The latter is more present in places like India, where citizens have digital identities established in government databases.
KYC verification refers to the process where financial organizations get to learn more about their potential and existing customers. The process allows these institutions to confirm that anyone making financial transactions using their services is being truthful about their identity, the source of their income, and their overall financial standing.
In turn, KYC can help manage financial risks, while also preventing money laundering, identity theft, and other illicit activities. Indeed, the concept is present and gains more attention in this day and era because of the complexities of the crimes that are present out there.
At the same time, it is essential to note that aspects such as money laundering, and other types of financial crimes will undoubtedly have an impact on the quality of life of a wide variety of people.
Remember that this effort ramped up after the events of 9/11 as a wide variety of laws were passed with regard to efforts in fighting terrorists. This need for KYC concentration required more resources for The Financial Action Task Force and related organizations that are involved in AML-related activity.
It can certainly seem like a victimless crime, but in many cases, these activities connected to financial crimes are indeed illicit in nature.
The policies are supposed to be in place to help catch illicit activity and those who are connected to this activity. At the same time, individuals have noted that it could lead to overreach and invasion of privacy. KYC proponents note that this aspect of financial regulation has more benefits than cons.
Due to these benefits, KYC is often a mandatory requirement under financial law in various territories.
KYC verification is mandatory in various financial institutions that may include but are not limited to:
- Commercial Banks
- Investment Banks
- Credit Unions
- Financial Services Organizations
- Cryptocurrency Exchanges
These organizations follow KYC procedures to view their customers and to have the right full picture on their customers. As they look at their customers and have a complete profile, they can understand the risks, and seek to proceed with these customers or not.
The process can break down into several aspects. A few of these aspects will range from visual ID verification and document-related information that confirms your place of residence. In some cases, it could include biometric-related verification.
The aspect of KYC makes these entities compliant with the relevant authorities and helps them to avoid penalties related to a lack of proper compliance. One might be interested to note that financial institutions have had to suffer cumulative penalties of over $20 billion over a decade or so due to issues in compliance in one form or another.
Of course, since these penalties usually leak to the public, the financial institutions who are suffering these penalties will also notice a reputational issue.
These institutions will have to act in a similar fashion for both individual and corporate accounts. So there is quite a bit attached to these components, and the fact that it is supposed to provide protection makes it seem quite compelling for the global citizenry.
This makes KYC one of the most crucial parts of financial safety for customers and organizations alike. As a result, cryptocurrency exchanges and other similar institutions in the crypto market have adopted this measure in the past few years.
The Importance of KYC Verification in Crypto Trading
After learning the basics of KYC in general financial institutions, it becomes easier to understand what is KYC in crypto trading. Simply put, reputable cryptocurrency exchanges and investment institutions have to follow the same practices as traditional organizations to manage financial risks and prevent financial crimes.
After all, these organizations are also dealing with money, it may be a more modern iteration of money and assets, but it is a financial tool or vehicle at the end of the day. This due diligence may be deemed to be more critical in the fast paced world of digital assets.
These different digital asset entities have seen a surge of investors and speculators who have flocked to their respective platforms. They must avoid escaping the KYC process and must implement it or face the consequences. It is not a surprise that the rules and regulations were lax when these entities were relatively new but then started to implement more KYC and AML-related practices when they started to see significant traction and activity.
This means that when you open an account at a cryptocurrency exchange, you have to provide at least the basic CIP details, including your name, date of birth, address, and identification number. From there, some institutions may also ask for further details to manage risks on your account.
Through this information, cryptocurrency institutions can prevent risks such as money laundering, terrorist activities, and identity theft. In essence, Virtual Asset Providers must validate customer identity, have a decent picture of their customers and relevant activities, and assess the risk of potential money laundering.
These digital asset entities must be aware of those individuals who are under sanctions or those who have other issues with governments. However, if these individuals are fantastic, according to the proverbial state, then they can proceed with their speculative and investing digital asset activities.
This makes KYC a crucial part of cryptocurrency trading.
This contradicts the popularized rule of privacy with cryptocurrency usage. But after understanding how KYC remains vital in keeping people and organizations safe from identity theft and financial risks, it becomes easier to appreciate why the process is crucial for cryptocurrency institutions.
Legal and Regulatory Requirements for KYC
There are legal and regulatory requirements for KYC. These are present within the United States and across the globe.
This is because the United States and other countries move forward with the same goals in mind, to ensure that there is proper data collection and general checks when it comes to moving money around.
As these countries collaborate to ensure that they all pursue the same goals effectively, we are likely to see a convergence when it comes to standards across the world. In addition, various countries are looking at ways to improve their systems and processes to ensure that they are enforcing these laws and regulations in the right way.
FinCEN, an organization in the United States, released its suggestions for KYC guidelines from late 2013 to mid-2014.
These requirements hone in on specific aspects like knowing your customer’s information, verifying their identities, and understanding their overall relationships when it comes to business transactions and other activities.
In essence, these authorities set foundational due diligence on customers that should go hand-in-hand with the current policies and processes that are already in place at a specific financial institution.
It is all about the standards plus the internal risk assessments that are present within these organizations. It is important to note that organizations can have varying risk profiles and assessments, and so there is a degree of interpretation present here.
Another critical factor is that these individual entities must look at how they account for the laws and regulations that are present across different countries. For example, some nations may impose more onerous laws while others may not have as many regulatory burdens for organizations to take on.
These entities will look at sanctions, places where cash is placed, if there are any ways that the customer is masking information and affiliations, if it is solely a digital relationship, or if it is a physical relationship.
Authorities have allowed companies to use the information of customers that are present on third-party sources to obtain great benefits. At the same time, in some cases, it may not be the right action to work with third parties. This is another example of why it is crucial to understand how to approach this and to work with those in the compliance field to have the right processes in place.
Financial institutions are expected to have the right policies and systems in place with the right resources, financial and human, to account for the evolving aspects of AML and KYC.
Types of KYC Verifications
The KYC process revolves around learning more about the customer, categorizing their information, and determining whether they need enhanced checks on their account activity to prevent financial risks.
Due to this reason, the KYC process is segmented into the following three categories:
Customer Identification Program (CIP)
This refers to the process of collecting documents and verifying customer identity through their name, date of birth, address, and identification number, such as social security number (SSN). This is where organizations may learn if the customers they are dealing with are on any sanctions lists, terrorism lists, or politically exposed person (PEP) lists.
Customer Due Diligence (CDD)
This is where the information obtained during CIP is utilized to segment customers according to their financial risks. During this process, financial institutions may require additional information, such as source of income and citizenship status, to learn further details about the customer.
Enhanced Due Diligence (EDD)
This process is executed for those customers who bring additional financial risks to the table. These customers are often labeled as high-risk clients. In such cases, institutions may impose active monitoring activities on accounts to detect suspicious behavior.
Apart from the four basic details, your name, date of birth, address, and identification number, KYC may also involve the submission of other information.
This may include:
- Copies or scans of your driver’s license or passport.
- Copies or scans of your recent financial statements.
- Proof of transaction from one of your existing financial accounts.
It is also important to remember that each cryptocurrency institution has its own requirements in place. Some might let you open an account with just an email and password, but will only let you make transactions once you verify the account with the required KYC details. On the other hand, others may require you to submit additional documents, including your photo ID, at the very start.
Regardless of the requirements that a cryptocurrency organization may bring to the table, you must comply with them to keep the industry a safe and reliable space for financial transactions.
How To Pass the KYC Verification Process in Crypto
Passing the KYC verification process is not difficult at all. As long as you provide truthful and legible information to the cryptocurrency institution, you may breeze through the process without any additional hiccups.
In order to pass the KYC verification process, you need to keep the following points in mind.
- Make sure that the personally identifiable information that you submit to the institution is factually correct.
- Ensure that the copies or scans of your identification documents are perfectly readable.
- Make it a point to have a recent photo upload available in cases where it is a requirement.
- Recheck all the information to determine that it is correct to the best of your knowledge before submission.
- Directly reach out to the cryptocurrency institution for questions or inquiries instead of getting your information from third-parties.
It is true that one main point earlier was that this should be a fairly straightforward and simple process. At the same time, remember that there is a simple caveat here to be aware of and to pay close attention to have the best results. As you are interacting with these digital asset entities, you may notice delays in processing and may notice general hiccups.
Many individuals have seen that their KYC and onboarding process took a while due to excessive demand from their trading peers.
Others have seen delays and further requests from digital asset-related entities because of issues with their processes or because of issues with the individual applicants themselves.
In times when there’s lower demand and traffic, individuals generally see no issues. But always note that there are situations where the system or the people who are involved in the compliance team of the company may want more information on the applicant for various reasons.
KYC and Data Privacy Concerns
Opponents of KYC have noted their concerns with data privacy concerns. It is crucial to break this part down a little bit further. They have data preservation concerns and privacy concerns as well.
There are those who think that there is quite a bit of information floating around in the ether already. As more information migrates to the internet because people input their credit card information, personal information, and other sensitive information for a wide variety of activities, in essence, too much information is already out there that various parties have.
More information is flying around to do business and various activities, and so that creates threats and increases the surface level of risk.
At the same time, there are those who will also believe that there may be excessive government overreach with these different programs that require more information.
Further parties have more information about you, but it is not the same in the opposite direction. For instance, you do not have similar types of information on them, and this provides them with much more leverage.
It is primarily a concern for those who think that there are increasing levels of government overreach across the world that may impose on critical freedoms such as the freedom of speech, liberty, and the pursuit of happiness.
Data Privacy
On the other side, we have the issue of data privacy. In this aspect, we delve into the aspects of data leaks, data storage, and overall security. In many cases, in the digital asset sector and in the traditional financial and business sector, we notice that there is replication at scale taking place.
For instance, you go to one exchange, conduct KYC to align with their respective procedures, and then notice a new digital asset shop opened up online. This entity offers lower fees and a significant amount of alternative digital assets.
You are excited by this prospect, and so you also add this other exchange to your repertoire. But this means you must resubmit your documents and go through the entire process again. Of course, this is fine for you, it is a bit of a hassle, but you can take advantage of a fantastic offering by a new entity.
Now, what if this new exchange is optimizing for an increase in users and may not have everything with regard to security in place? It gets hacked. Then hackers have quite a bit of sensitive information and may have your assets to boot, depending on the level of the hack.
In essence, at the present moment, there are cumbersome systems. These are inefficient and clunky. These checks should be more streamlined and straightforward. Whether one was to look at the significant EquiFax incident or other breaches, one can expect that vulnerabilities are present in the system.
The question is, are there singular solutions that can address these concerns? Is there an issue with a singular solution due to the potential concentration of significant information? At the same time, singular solution options have not panned out in the marketplace because of different relationships with risk mitigation and transference firms.
The idea is to conduct the verification and to create a sense of safety overall while making it to where there is collective mitigation of vulnerability.
There are digital asset entities that have sought to solve problems similar to this with online identities on the blockchain. This innovation would improve and enhance the customer experience across different platforms.
It would do so by potentially having a more secure way of signing on and verifying information via the blockchain. At the same time, the system would have to be designed effectively to where it is genuinely decentralized and safe for the best results and true safety. A solution that can adhere to the decentralized ethos will prove to be an ideal solution.
Is There a Chance That My Documents Could Be Requested by Local Police or Government Institutions
Local police or government institutions may ask for these documents. But the expectation is that they will ask for these documents if there is a reason to suspect that the individual is not up to par with government regulations and laws.
There has yet to be a significant amount of cases that are known to the public and covered by the media of incidents where the local police or governmental institutions requested documents.
It is important to note that there have been high-profile incidents where institutions like tax authorities have reached out to exchanges to learn more information about users on their platforms and records.
The Coinbase incident comes to mind in the 2018-2023 timeframe. It is likely that there have been other more under-the-radar requests that exchanges may have obliged and met.
A key point here is to ensure to keep your data safe and to follow best practices all around for the best results.