The philosophy behind cryptocurrency is essentially decentralized empowerment. Rather than using traditional financial systems, cryptocurrencies aim to enable peer-to-peer transactions, remove intermediaries, and give individuals more control over their financial assets. With a foundation rooted in anonymity and censorship resistance, how does know your customer (KYC) — a process of identifying customers used by traditional financial institutions — fit into the crypto landscape? Does it have a place? How can KYC be employed by the crypto industry? We’ll explore these answers and more in this brief guide to crypto KYC providers.
Why is KYC important in crypto?
KYC plays an important role in the crypto industry — the use of KYC by crypto providers helps with building trust, mitigating risk, meeting global standards, and creating long-term viability. Let’s take a closer look at each of these benefits.
- Building trust. At its core, cryptocurrency requires trust, as the entire system operates using decentralized networks that are outside of traditional financial structures. Although it’s commonly thought that crypto is anonymous, the truth is that this anonymity isn’t absolute. Most transactions are permanently visible on the blockchain, although ownership of the wallets at either end of the transaction is usually unknown. Using KYC procedures can help build trust with users, regulators, and the wider financial community, ensuring that each transaction is actually going to the right person, making identity fraud and money laundering more difficult for bad actors.
- Mitigate risk for investors. Most cryptocurrencies have an initial coin offering (ICO) as well as token sales. Using KYC gives confidence that the funds being contributed come from legitimate sources, ultimately protecting investors from potential scams.
- Meet global standards. Although crypto was born out of a rejection of the traditional financial system, the industry has become more mainstream in recent years. This increase in adoption puts pressure on cryptocurrency exchanges to meet global financial standards, many of which require KYC compliance.
- Create long-term viability. In order to gain wider acceptance and adoption, it’s vital for the crypto industry to demonstrate that it can uphold the same standards — like KYC regulations — that traditional financial systems adhere to.
What happens when KYC is not verified in crypto?
Potential consequences of using a non-KYC crypto exchange without identity verification include money laundering, fraud, scams, and bad actors gaining unauthorized access to accounts and funds. A reputable KYC crypto exchange on the other hand will require KYC verification for access to certain services, like trading, withdrawals, or higher transaction limits. This helps prevent potential fraudulent activities.
If the exchange has KYC in place and users aren’t able to complete the verification process, there are a few reasons why this may be happening. If the verification fails while checking credit database records, this could mean that the user does not have a detailed enough credit file. If the error occurs during document or biometric verification, this could mean the submitted data is not high enough quality. When using Onfido’s Smart Capture, these issues are easily avoided. Our technology makes the user experience smooth, providing quality captures the first time a user submits for verification.
Is KYC mandatory for crypto?
Regulations vary globally, but KYC is being more frequently mandated by financial regulators. In fact, in 2019, a joint statement from the U.S. Securities and Exchange Commission, Financial Crimes Enforcement Network, and Commodity Futures Trading Commission clarified that crypto exchanges are money service businesses, which means they are subject to KYC rules under the Bank Secrecy Act of 1970.
Each exchange that converts fiat to crypto or crypto to fiat is responsible for implementing KYC measures. For example, Coinbase states in their terms of service:
“Coinbase uses identity verification in order to comply with Know Your Customer (KYC) laws. KYC is a way to identify and confirm that a customer is who they say they are. It’s a multi-step process that helps prevent the creation and use of fraudulent accounts. As a regulated financial services company, Coinbase is required to identify the users on our platform. Per the Coinbase User Terms, we require all customers to verify their identity to continue using our service. We didn’t always require Identity Verification to sign up for Coinbase, but we now require all customers to input their information. This means any customer who signs up for Coinbase, as well as any customer who is currently on our platform who never verified their identity in the past, needs to verify their identity in order to continue using Coinbase.”
However, Phemex, another popular crypto platform states:
“Phemex has adopted KYC procedures to better comply with local regulations and to ensure secure platform operations for all users. KYC is currently not mandatory, but we highly recommend that you complete KYC to enjoy the full suite of services offered on our platform. Customers who do not complete KYC will face certain service restrictions on our platform, such as not being eligible for certain bonuses or campaigns.”
As you can see, the scope and strictness of KYC requirements vary depending on the platform and applicable regulations. If an exchange does not offer conversion from crypto to fiat or vice versa, they can fall into a gray area. Some of these exchanges have voluntarily chosen to follow KYC regulations.
How is KYC done in crypto?
KYC in crypto is performed similarly to KYC in other sectors, although the focus is primarily on identity verification. A robust KYC process should include:
- Customer verification where personal information like name, address, date of birth, or other data is collected to help prove the potential customer is real and the person they say they are.
- Customer due diligence where the crypto exchange checks to make sure customers are not included in sanctions screening, PEPs screening, watchlists, and other KYC measures.
- Risk scoring/decisioning where they decide if the customer can continue onboarding, if further due diligence is needed, or to reject the application.
- Ongoing monitoring for red flags during the customer’s lifecycle that could indicate potential fraudulent activity.
Partnering with a crypto KYC provider is an effective way to ensure KYC checks are performed accurately and efficiently, streamlining the process for crypto exchange users.
How do I choose a KYC provider? With Onfido, you can be confident in your crypto KYC.
Remember Phemex, the exchange from the earlier example? They are just one of the many established crypto exchanges that have partnered with Onfido to ensure seamless and effective KYC. Our identity solutions include ID record checks, sanctions screening, PEP screening, adverse media screening, and ongoing monitoring. Our market-leading document and biometric verification services make it simple to verify users’ real identity quickly.