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According to the latest data, the crypto market has nearly 550 crypto exchanges and more than 22,000 unique crypto assets. The volume of users that deal with crypto assets is equally immense, with a few reports estimating the current number of crypto users worldwide to be more than 420 million.
With this many people engaged in the market, it is crucial to do proper identity management to avoid fraud and protect consumer rights. It is where the Know-Your-Customer (KYC) regime becomes vital in the crypto world while prioritizing user experience throughout the process.
Before moving forward with the topic of crypto KYC, we would like to reiterate that it is crucial to maintain a delicate balance between compliance and privacy user experience, which, if impacted, can deal a severe blow to the entire crypto ecosystem. This is the exact philosophy that Shyft Network believes in and works for while engaging with all stakeholders, be it Virtual Asset Service Providers, such as crypto exchanges, regulators, and more.
KYC is the very crucial first step towards anti-money laundering due diligence. All financial institutions carry out KYC procedures when onboarding new customers to their platforms. Apart from a robust identity verification process, KYC also helps assess a customer’s risk profile and ascertain the financial risk-taking tendency of individuals.
When it comes to crypto assets, KYC is applicable to all types of Virtual Asset Service Providers (i.e., crypto exchanges, crypto wallet service providers, staking service providers, etc.).
For crypto exchanges, crypto KYC is a process through which the exchange confirms its end users’ and customers’ personal information. It helps exchanges have a deeper understanding of the intention of their users and verify their legality. It also helps understand how probable it is for a customer to pose money laundering risks to an exchange or even to finance illicit activities.
For crypto exchanges, the Financial Action Task Force (FATF) has recommended a risk-based approach for KYC compliance. The intensity of the compliance measure could increase or decrease depending on the customer’s risk profile.
Under this paradigm, exchanges should start by collecting and verifying identifiable customer information, such as their names, addresses, date of birth, and other relevant information. Once done with this process and onboarding is complete, exchanges should keep tracking their customers’ transactions regularly.
KYC is considered extremely efficient in preventing any potentially fraudulent or criminal activity. To fulfill their obligations, exchanges keep strict vigilance on unusual transaction patterns that are starkly different from the existing transaction style of a customer.
Cryptocurrency exchanges also monitor transactions that have high-risk customers as parties or involve locations considered to be high-risk. By doing so, they can track illicit cryptocurrency transactions.
Keeping consistent track of customers is also relevant because their status may change from time to time depending on the fluctuations in the larger scenario. For instance, they may suddenly come under international sanctions, get politically exposed, or be affected by negative news stories. These factors may result in customers becoming riskier.
Virtual Asset Service Providers, which is a broader category that includes all crypto-related service providers such as exchanges and more, also have multi-step KYC programs. It starts with the collection of customers’ personally identifiable information, or PII, such as name, place, date of birth, address, etc.
The next step for the VASPs involves tallying or cross-checking the integrity of this information with available identification documents such as a passport or driver’s license, proof of residence, utility bill, etc.
Then comes the step where VASPs must verify the customer against the list of sanctioned individuals or Politically Exposed Persons.
As discussed already, KYC is a process that involves a sequence of identity verification, customer monitoring, screening, and tracking.
It is a process that results in collecting and storing large amounts of private data. This data includes both digital customer and transaction data. For a decentralized, intermediary-free regime like web3 and crypto, it is sensible that this process runs through automation. And having a software solution embedded in the exchange or VASP terminal helps improve process speed, efficiency, and accuracy. Automation also helps in achieving scalability with depth.
For example, Shyft Veriscope is a fully automated FATF Travel Rule Solution that helps VASPs fulfill their Travel Rule regulatory obligations without any manual involvement from either the originator VASPs (read: crypto businesses from where the transaction is originating) or the beneficiary VASPs (read: crypto businesses receiving the transaction). Here's what the entire process of Travel Rule compliance looks like for VASPs using Shyft Veriscope:
And given the evolving nature of the crypto world, we expect KYC checks to strengthen even further. That's where automated processes help crypto firms offer enriched KYC compliance mechanisms that align with what the present era of cybersecurity demands.
Apart from an enhanced level of transparency and trust in the ecosystem, the benefits of KYC processes are multiple.
While most discussions on KYC compliance methods revolve around preventing fraud and protecting a provider from potential breaches or attacks, its benefits create a win-win proposition for both the provider and the user. Since KYC measures ensure a safe ecosystem, providers with a robust KYC mechanism offer a transparent system to the users. It also helps providers gain trust in the market.
According to data, crypto frauds are increasing. Market estimates claim that between January and November 2022, cyber attackers stole cryptocurrency worth US$4.3 billion between January and November 2022. It was a growth of 37 percent compared to 2021. Having KYC processes in place will help reduce this volume. Resultantly, stability in the market will increase, and both the user and provider will make profits out of their dealings in this space.
It is also vital that the cryptocurrency market gains stability, as crypto assets are often marked by volatility. As an entirely new regime in concept and implementation, crypto assets often see price corrections resulting in market fluctuations. Adverse news of frauds and breaches in the market amplifies this volatility.
KYC compliance methods, ensuring a user population of verified customers and consumers, reduce the probability of having anonymous transactions in the market, resulting in a lessened chance of fraud.
KYCs also empower exchanges with the competitive advantage that a secure business brings with it. Exchanges operating without robust KYC mechanisms not only live in fear of hacks and breaches resulting in losses worth millions of dollars but also stay vulnerable to regulatory changes.
Jurisdictions that are lenient today might tighten up their regulatory noose tomorrow. Businesses or providers that already adhere to a deeply thought-out KYC process can adjust to these regulatory compliance shifts faster, staying ahead of their competitors in the space.
That said, every crypto company must design its KYC process with users in mind. Compliance, although important, must not come at the expense of user experience and privacy. Both must be prioritized to provide a smooth transition to a regulated future from an unregulated one for the benefit of crypto users.
Data security is a complex task. To keep their customer’s data safe, crypto exchanges must start with a robust data privacy and protection policy. Most cryptocurrency exchange websites have their privacy policy published on their website. Customers may go and check these pages in detail to understand whether the data handling is adequately safe or not.
Transparent dealing with third parties is also crucial in the safe handling of customer data. There are two types of third parties involved. The first is the partners who service cryptocurrency exchanges and service providers leverage to maintain their websites and process trades.
Since such an arrangement requires mutual sharing of data to an extent, exchanges must do it securely and safely. Many well-known exchanges share the name of such third parties on their privacy policy page or at some place on their website. It helps increase trust and transparency in the process.
There exists a second type of third party from which cryptocurrency exchanges and platforms gather information about their users. These types of third-party providers of information may include banks, government organizations, social networks, anti-fraud databases, public court documents, sanction lists, etc. For authentic and credible data, platforms collecting information must ensure that they use the latest data sources and cross-check from multiple terminals in compliance with bank secrecy acts, terrorist financing laws, etc.
When it comes to the compliant and secure exchange of cross-party information, Shyft Network’s one-of-a-kind Travel Rule Solution, Shyft Veriscope, enables VASPs to comply with the FATF Travel Rule by exchanging user KYC data with counterparty VASPs securely. And at no point does the user KYC data pass through Shyft's internal servers, as the exchange of user data on Shyft Veriscope is exclusively done between VASPs in a peer-to-peer (P2P) mode. Click here for more details on Shyft Veriscope.
Like all scrutiny and identity verification processes, cryptocurrency exchanges also face risks often inherent to designing the KYC process. For instance, KYC requirements and similar due diligence processes often follow a check box approach without going deep about identifying the industry-specific requirements.
The process often lacks integration with the exchange’s operational model and stays only as a customary addition to abiding by the rules of the land, making the process inefficient. If the KYC technology is inefficient, it may take a lot of time to onboard a customer. It slows up the process and acts as a deterrent to new customer acquisition.
Since data sharing is involved in the process, the crypto exchange needs to have its data protection mechanism empower its KYC and Anti Money Laundering (AML) efforts to the fullest. Otherwise, investors and consumers using the platform stand the risk of compromising their personally identifiable information.
The most prominent challenge that crypto exchanges face in implementing robust KYC regulations is the lack of homogeneity in the system. Different countries have different crypto laws. For an exchange to become international or global and facilitate crypto transactions between two counterparties sitting in different jurisdictions requires compliance with both laws. Divergence among countries implies that the crypto exchange would have to spend significant effort and resources in streamlining and consolidating its KYC policy.
Cryptocurrencies belong to an industry that is emergent and evolving. Even if an exchange chooses to operate within a single geography, it may face changing regulatory paradigms from time to time, raising the need for constant updates in the KYC procedure and technological changes.
KYCs help the industry to become more secure. Every day, countries are introducing new crypto regimes. The EU is coming up with Markets in Crypto Assets Regulation. Crypto service providers are becoming increasingly compliant with KYC needs so that there is no deviation from what the international and global regulators want. It makes them safe and efficient and increases trust among users. Yet, there exist some crypto wallets that do not require KYC and cater to people who want to stay anonymous.
It is still possible to buy crypto without KYC. There are P2P platforms, Decentralized Crypto Exchanges, and some major exchanges that allow buying crypto without KYC.
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VASPs need a Travel Rule Solution to begin complying with the FATF Travel Rule. So, have you zeroed in on it yet? Check out Veriscope, the only frictionless crypto Travel Rule compliance solution.
Visit our website to read more: https://www.shyft.network/veriscope, and contact our team for a discussion: https://www.shyft.network/contact.
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