Over the last little while, crypto exchanges have been actively implementing the so-called situational KYC procedure to combat the growing number of illegal activities such as money laundering and terrorist financing, while striving to maintain a high level of user experience (UX) and financial independence.
What exactly is KYC?
KYC, which stands for “Know Your Customer,” is a security process integrated by financial institutions to verify the identity of their clients. This procedure consists of collecting and analyzing various customer data to confirm their identity and to assess the risks of their activities, as well as to ensure compliance with anti-money laundering (AML) and counter-terrorist financing (CTF) regulations.
The KYC procedure typically involves the steps as follows:
- Data gathering. Financial entities collect various data about the customer, including personal info such as full name, address, date of birth, IDs, and financial state.
- Verification of customer data. Once the data is captured, it is then verified for authenticity. For instance, IDs can be verified through government databases or other verification tools.
- Customer risk rating. Based on collected and verified information, exchanges perform risk ratings for each customer. This may include analyzing the client’s source of funds, the nature of the client’s business, among others.
- Continuous monitoring. Once the initial KYC is completed, financial institutions can keep monitoring the customer’s activities for as long as they utilize the company’s services. Doing so helps to identify suspicious or out-of-the-ordinary transactions.
The purpose of such procedure is to mitigate the risks of unlawful practices such as previously mentioned money laundering, terrorist financing, corruption and other criminal activities. What’s more, this procedure assists in protecting financial institutions from engaging in such illicit acts and ensures overall financial security.
KYC in keeping crypto exchanges safe
KYC is considered crucial to the security of DEXs for a number of reasons:
- Cracking down on illegal activity. Here KYC is aimed to facilitate the customer authentication and help exchanges assess their potential exposure to illegal activities such as the abovementioned money laundering and terrorist financing. As a result, exchanges can foster a safer trading landscape by requiring users to provide personal details and IDs, thereby avoiding the exploitation of their services.
- Stepping up transparency. Such a procedure also ensures that DEXs provide a higher level of transparency by eliminating the clandestine activities with illicitly obtained funds. This cuts the risk of DEX being misused for illegal purposes and helps bulid up trust with investors.
- Gaining reputation. Introducing KYC benefits exchanges by managing the goodwill and risks posed by hacking attacks or data breaches. By responding to suspicious activity quickly, DEXs can minimize the severe consequences to their reputation as well as to investor confidence.
- Complying with regulations. There are plenty of countries that impose strict regulatory standards on crypto exchanges, not to mention these mandatory KYC practices. Staying compliant with these requirements is a way to protect exchanges from potential fines and other negative implications that could be brought by financial watchdogs.
KYC in general is an essential tool for providing better security and regulatory compliance on crypto exchanges. As articulated earlier, this process serves to deter illegal activities, boost transparency, and strengthen investor confidence, which ultimately contributes to the strady development of crypto market as a whole.
The total value held by illegal addresses in crypto hit an all-time high of $20.6 billion back in 2022, marking a notable surge from $18.1 billion as of 2021. Such an uptick is due to heightened level of illegal activity in the cryptoverse. We can observe that the use of anonymous public addresses and the lack of security measures fuel the spread of such activities, hence the widespread adoption of KYC.
Advantages of non-mandatory KYC
It is worth mentioning that there are numerous advantages to another type of KYC, the non-mandatory one.
Unlike mandatory KYC, the non-mandatory approach to customer verification keeps users’ privacy intact by allowing them to perform transactions with no personal info disclosed. For those who value their private space and do not feel like sharing their sensitive data, this point is of utmost importance.
Furthermore, non-mandatory KYC can be cost-effective for both users and platforms. Since the verification procedure is not mandatory for all users, platforms can avoid the hefty costs of maintaining comprehensive KYC checks. This also allows for lower fees to be charged from users, making your services more eye-catching to a wider audience.
For instance, in a CeDeFi ecosystem, Changelly uses an automatic risk prevention system and only requires verification if a transaction triggers the risk scoring system. This simplifies the overall user experience, granting them immediate access to services with no need to endure complicated authentication procedures.
Enabled only under certain circumstances, such KYCs facilitate the signing-up process while ensuring the platform security is maintained. Such a flexible approach helps meet regulatory guidelines and secure operations by avoiding unnecessary hurdles for users.
How does non-mandatory KYC support crypto adoption?
Non-mandatory KYC is crucial in supporting the proliferation of cryptocurrency by offering a flexible approach to regulatory compliance. With this strategic approach, threshold for newcomers can be lowered, which is particularly helpful in regions with limited access to conventional banking services. Crypto trading venues that do not require KYC for small transactions or basic account features open up an opportunity for individuals who value anonymity and confidentiality to participate in the crypto economy.
By carefully implementing mandatory and non-mandatory KYC practices, platforms can protect users from financial risks. Say, Changelly previously assisted Europol and other law enforcement agencies in tracing the criminals and returning funds to the customers affected by hacks. Thus, it helps develop trust in crypto platforms.
In the years to come, the integration of KYC processes is poised to shape a more secure, transparent and inclusive digital finance landscape. Platforms that leverage advanced technologies and adopt flexible KYC practices will drive global crypto adoption to new heights, providing great convenience and top security for everyone.
Conclusion
KYC procedure plays a vital role in ensuring safety and transparency in the financial space and the cryptocurrency sector in particular. The perks of mandatory KYC include the ability to identify and mitigate the risks of unlawful financial activity, as well as to meet international regulatory standards. However, mandatory KYC may raise concerns about user privacy and also set up extra thresholds to using the desired services.
Conversely, non-mandatory one can diminish barriers for newcomers and empower those who value anonymity to engage in financial transactions. That said, non-mandatory KYC can also magnify the risks of financial crime and make it more challenging to investigate crimes.
Weiighing up the pros and cons of KYC in general is imperative to ensure that financial crime is tackled effectively while preserving one’s confidentiality and ensuring that financial platforms are accessible to whomsoever. In fact, having versatile and innovative approaches to KYC that meet the needs of users while ensuring security and compliance with legislation is paramount. It is the only way to achieve a sustainable and trustworthy financial environment for all market players.