AML And KYC: The Need Of The Hour For Crypto Exchanges

Melissa IN Team | AML, KYC | , , , ,

While cryptocurrency may still be far from being accepted as legal tender in most countries, it is one of the reigning investment routes. The transparency offered and ease of investment are probably the two most important factors contributing to its popularity. But, the convenience it offers has also made it attractive for money laundering and terrorist funding. This is a global problem that has brought about the need for strong Anti-Money Laundering (AML) legislation and Know Your Customer (KYC) processes. The challenge now for crypto exchanges and wallets is to balance regulatory compliance with a smooth customer experience.

What Are AML And KYC And How Do They Impact Cryptocurrency?

Anti-Money Laundering (AML) is an umbrella term that covers all regulatory processes used to prevent and combat money laundering, tax evasion, terrorist funding and other such financial crimes.

While AML and KYC are often used interchangeably, KYC is a part of AML. This is the first step of an AML program designed for financial institutions to find out the true identity of their customers. For this, the crypto exchanges must collect Personal Identifiable Information (PII) such as the customer’s full name, date of birth and address.

The data collected from the customer must be verified against government-issued documentation and third party databases to ensure that the customer is who he/ she claims to be.

Once this information has been collected, due diligence is done to assess the customer’s risk of being a fraudster. This determined by checking points such as:

• Is the individual’s name on a sanction list?
• Is the individual connected to any terrorist groups?
• Is the individual politically exposed?
• Has the individual been blacklisted by any financial organizations?

What Is The Current AML And KYC Legislation For Cryptocurrency?

While KYC and AML regulations for traditional financial institutions like banks are relatively well-defined and standardized around the world, legislation for cryptocurrency varies from country to country. While the USA requires all cryptocurrency exchanges to conduct KYC and AML programs for all customers, the EU requires such checks to be conducted only in the case of fiat-to-crypto exchanges.

India is yet to standardize KYC and AML norms for cryptocurrency exchanges. This leads to the questions – why worry about KYC now?

Importance Of KYC For Crypto Exchanges

As a customer, would you bank with an organization that a news report said criminals were banking with? Or one that had recently been hacked into and been subject to financial crime? Establishing KYC norms minimizes the risks of such instances and helps cryptocurrency exchanges demonstrate their trustworthiness. Here’s how.

Build Transparency And Trust
When a crypto exchange asks customers for their PII, the customer knows that this is a basic requirement for all the exchange’s other customers as well. Thus, the risk of known criminals being on the exchange is very low. This level of transparency builds trust in the exchange.

Minimize The Risk Of Being Subject To Financial Crime
In 2019, cybercriminals were able to siphon off $4.26 billion from cryptocurrency exchanges and users. How did they do this – fraudsters registered as customers with exchanges that did not conduct stringent KYC checks and opened the door for phishing attacks, hacks and scams.

Reactive studies of many of these cases have shown that KYC processes could have identified the cybercriminals before they entered the database and thus prevented such heists.

Build Confidence In Peers
In the case of cryptocurrency, customers must trade with each other for the exchange to be successful. For this, they must be able to trust other people on the exchange. If there are too many cases of fraud such as chargebacks, social engineering, dots and commas scams, etc. customers will stop trading with each other.

KYC keeps this from happening by identifying identities with a high risk of criminal activity and keeping them out of the database.

Now That A Need Has Been Defined How Can Crypto Exchanges Streamline KYC Processes?

Manual KYC is next to impossible for crypto exchanges. This is time-consuming, takes too much effort, doesn’t offer 100% guaranteed results and causes friction in the onboarding process. Waiting for their identities to be manually verified can take days and in the meantime, customers may turn to competitors. There’s also an issue of scalability.

The good news is that this process can be digitized. Identity verification tools can automate KYC processes for smoother, faster and safer customer onboarding. This software could use simple document verification techniques or even biometrics.

Document Verification

In the case of KYC through document verification, the details entered by the customer are checked against data stored in government and other reliable third-party databases. If there’s a spelling error or a difference in date of birth, the entry can be flagged in real-time and kept from entering the exchange database.

Similarly, in the case of addresses, the customer may be asked to provide supporting documents such as telecom or utility bills. These are checked against other databases to ensure that it is accurate, valid and complete. For example, the customer may have missed out on entering the floor number for his apartment but this gap in information can be easily bridged during the KYC process. As identities are being verified, they are also run against sanction lists, etc. to weed out malicious users.

Biometric Assessment

In addition to asking for supporting documents to prove their identity, crypto exchanges may also require customers to upload a selfie or a video of themselves with valid photo identification. Biometric facial recognition software can be used to check whether the individual holding the document is the same as the individual in the picture on the document.

Concluding Thoughts

If not today, then KYC and AML processes will become compulsory for Cryptocurrency exchanges by tomorrow. There’s no escaping it – rather, it is better to be proactive and design effective policies now. Automated KYC processes will not only protect the exchanges from financial crime but will build a trustworthy reputation while maintaining a seamless customer experience.