As cryptocurrencies become more popular among investors, governments worldwide are trying to regulate this new asset type. The European Union (EU) was the first to require crypto service providers to detect and stop illicit uses of crypto assets. In the United States, the Biden administration began exploring crypto regulation through the “Comprehensive Framework for Responsible Development of Digital Assets,” released in 2022.
Regulations aim to integrate crypto exchanges into the global financial system, which includes banks and other institutions. However, the cryptographic implementation of cryptocurrencies on blockchains makes transactions between users anonymous in most cases. Moreover, crypto transactions usually are completed in a few seconds. The anonymity and high speed of crypto transactions facilitate criminals to evade conventional anti-money laundering and countering the financing of terrorism (AML/CFT) controls.
Without compliance with AML/CFT measures, crypto exchanges cannot interact and do business with traditional financial institutions and banking partners. Hence, addressing this issue is critical for integrating crypto exchanges into the mainstream financial system. A top concern for regulators is the anonymity associated with crypto transactions, which can be addressed by implementing suitable know-your-customer (KYC) processes.
What is KYC in Crypto Exchanges?
A KYC process ensures a crypto exchange knows who its customers are and how they use its services. This way, exchanges can more easily detect malicious players using their services and prevent criminal activity like money laundering and terrorism financing. However, implementing KYC is more challenging for crypto exchanges than traditional financial institutions. The KYC verification process for crypto exchanges works as follows:
- Collect basic information. When onboarding a new customer, a crypto exchange must first collect basic identifying information about the user, such as name, address, date of birth, and social security number. Exchanges should use digital customer due diligence (CDD) tools to minimize human error when collecting this information.
- Verify customer data. Exchanges must ensure the data collected through a KYC process is accurate and up-to-date. Verification is achieved by corroborating data with official documents like passports, licenses, and birth certificates. In addition, exchanges must screen data against official lists, such as criminal registries and watch lists.
- Assign a customer risk rating. With all the above information, exchanges must calculate a risk rating. This factor represents the likelihood that an individual customer is involved in financial criminal activity. It also represents the compliance risk for a crypto exchange.
- Ongoing risk review. Customers with an acceptable risk rating can begin trading cryptocurrencies on an exchange. However, KYC is not only performed when a new customer signs up. A crypto exchange must continuously review and update every customer’s risk profile.
KYC Benefits for Crypto Exchanges
Why should crypto exchanges implement KYC besides complying with regulations? There are additional benefits, including:
- More trust and transparency. By implementing KYC checks, crypto exchanges demonstrate their commitment to operating safely and responsibly. As a result, customers and other stakeholders will trust the exchange more, and banks and other institutions will be more open to doing business as their reputations will not be at risk.
- Prevent financial crime. KYC helps avoid crypto transactions by people involved in criminal activity such as money laundering, terrorist financing, and fraud. A robust KYC process deters many financial criminals and fraudsters from operating.
- A more stable crypto market. Anonymity plays a role in making the crypto market highly volatile. KYC can contribute to stabilizing the crypto market by creating a more secure environment for institutional investors.
Hence, crypto exchanges without KYC will not enjoy the above benefits, and, perhaps more critically, they will not be able to do business with banks and other financial institutions. Most instant exchanges allow users to trade cryptocurrencies without KYC. But as regulations become tighter, they must implement KYC to ensure they are part of the global financial system.
Conclusion
Know-your-customer (KYC) processes are essential when it comes to crypto transactions. Using a cryptocurrency exchange platform that does not perform customer KYC/AML verification could be liable for most kinds of illicit activities. When trading and investing on these platforms, you must have a high level of trust in the team running the exchange. In this regard, LetsExchange.io is an instant exchange that implements the highest level of security. Users can confidently trade cryptocurrencies without any security concerns.