Know Your Customer (KYC) Verification Guide for Cryptocurrency Trading

Know Your Customer (KYC) Verification Guide for Cryptocurrency Trading

Peel back the cloak of anonymity in crypto! Discover how KYC and AML regulations are changing the landscape for crypto companies and keeping the digital frontier in check.

Regulators have made Know Your Customer (KYC) and Anti-Money Laundering (AML) rules mandatory for some crypto companies to discourage illegal activity. This article explains what KYC requires and which crypto businesses must comply.

Cryptocurrencies provide a degree of anonymity that has become a cloak for some to hide their dirty affairs. However, as the cryptocurrency industry has matured, regulators have wised up, rolled the Financial Action Task Force into crypto town, and demanded that hombres like exchanges and wallets know exactly who they're dealing with — amigos and enemies alike.

The new laws of the land — Know Your Customer (KYC) and Anti-Money Laundering (AML) procedures — have been enforced for a while, so chances are you know what we are talking about. These aim to mitigate the risks of cryptocurrencies being used for illicit purposes.

However, should you wonder what acronyms like KYC and AML are all about, you’re welcome to this primer, where we explore what they mean and how they work.

What Is KYC in Cryptocurrency?

KYC, or "Know Your Customer," is a procedure employed by financial institutions to confirm the identities of their clients. Its primary objective is to combat money laundering, terrorist financing, and other financial crimes by ensuring customers are who they claim to be. The catalyst for KYC's development and widespread adoption was the 9/11 events in the US.

👉 This process is not exclusive to the cryptocurrency sector, as it originated as a regulatory measure for traditional financial organizations such as banks. Nowadays, it serves to bring transparency and security to the crypto realm.

KYC procedures typically commence before an individual becomes a customer, with financial institutions verifying a potential client's identity prior to account opening.

Due to the absence of standardized legal verification procedures, this process can vary among organizations. Generally, the KYC process necessitates customers to submit personal details like their name, address, date of birth, and a government-issued ID. This information is then validated through various means, including document authentication, biometric checks, and cross-referencing with public records. Once the customer's identity is confirmed, they can access the services they requested, such as buying, selling, withdrawing, or lending cryptocurrencies.

It is crucial to recognize that KYC is a legal obligation in numerous jurisdictions. Noncompliance with KYC regulations can result in penalties for businesses, an outright ban on activities, or even criminal prosecution.

Cryptocurrency KYC Process: How KYC Is Done

Typically, the onboarding process for crypto KYC checks consists of these steps:

  1. Identification: Collecting the client's personal information such as name, address, date of birth, etc.
  2. Liveness check: Verifying that the client is a real human being and not an automated bot. This is done using technologies like facial recognition.
  3. Verification: Cross-checking the client's personal information with government-issued ID documents like passports to confirm authenticity.
  4. Address verification: Confirming the client's claimed address to determine if they are from a high-risk country or jurisdiction.
  5. Risk scoring: Categorizing the client's risk level based on the information collected in the previous steps. High-risk clients undergo enhanced due diligence.

The Financial Action Task Force (FATF) recommends that cryptocurrency exchanges take a risk-based approach to KYC compliance. This means that low-risk customers will undergo simpler KYC measures, while high-risk customers will face more stringent KYC checks.

In addition, FATF guidelines suggest that crypto exchanges should continuously monitor their customers. They should:

  • Ensuring customers are not affected by international sanctions;
  • Determining if the customer is a politically exposed person (PEP);
  • Keeping an eye on any negative media coverage involving the customer.

The risk-based approach helps focus resources on higher risk areas. Ongoing monitoring and enhanced due diligence for high-risk clients help ensure compliance even after initial KYC verification.

To efficiently and accurately conduct KYC, cryptocurrency companies often outsource the process to third-party KYC service providers who specialize in this domain.

Know Your Customer Requirements: What Documents Do You Usually Need to Provide for KYC

The specific KYC steps and documents required can vary depending on the organization and the country of your residence. You may need to provide a subset of the following information:

  • Personal details such as full name, date of birth, social security number or equivalent national identification number
  • Government-issued photo ID such as driver's license, passport or national ID card
  • Proof of address such as a utility bill or bank statement in your name
  • Additional documents like PAN card or voter ID card in some countries
  • Information on how you intend to use the organization's products and services

The list of KYC documents helps verify your identity and address. Questions on intended use of services help determine your risk category and monitor for any suspicious activities. The requirements may differ based on the type of organization and local regulations in the your country or region.

What Cryptocurrency Services Require KYC

From exchanges and custodial crypto wallets to peer-to-peer (P2P) marketplaces, the array of services that might require KYC expands even further:

  • OTC (over-the-counter) trading services
  • Crypto lending platforms
  • Payment processors
  • Token sale platforms

However, it is not the specific type of service provided by a company that mandates KYC compliance. Two primary factors play a crucial role:

  • The jurisdiction in which a crypto firm aims to operate;
  • The volume of funds it handles.

The geography of operation plays a significant role, as many jurisdictions do not allow crypto firms to operate without implementing some form of KYC process. For example, the EU countries and the United States are heavily regulated markets.

In the U.S., crypto assets fall under the Bank Secrecy Act (BSA), and all cryptocurrency exchanges must register with FinCEN and require users to verify their identities to comply with AML and CFT regulations. Additionally, the IRS requires crypto service providers to report users' earnings on cryptocurrency exceeding $600 as income, which is subject to taxation.

The EU has implemented several initiatives affecting KYC, such as AMLD5, AMLD6, the "Travel Rule," and MiCA, which all contribute to a more regulated environment for crypto-asset service providers.

On the other hand, some countries offer a more lenient regulatory climate for crypto-related firms, such as the UAE.

Trade volume also influences the degree of KYC scrutiny. Larger players, like Binance, typically have stricter KYC requirements, while smaller exchanges or services may have more relaxed checks, such as allowing unverified users to trade up to a certain threshold. However, industry standards for initiating KYC are still evolving, so there is no one-size-fits-all approach.

KYC Compliance for Exchanges

In Europe, the Fifth and Sixth Anti-Money Laundering Directives (AMLD 5 and AMLD 6) and the FinCEN Final Rule in the USA clarify that virtual currency exchanges must adhere to anti-money laundering laws.

👉 Despite these regulations, a Coinfirm study found that 69% of the 216 surveyed crypto exchanges lacked comprehensive and transparent know-your-customer (KYC) procedures.

An effective AML program includes a Customer Acceptance Policy (CAP), a Customer Identification Program (CIP), ongoing transaction monitoring, and risk management procedures.

CAP involves identifying new customers using official documents, while CIP verifies customers using the provided documentation and official databases. Ongoing monitoring requires crypto exchanges to have systems in place that can identify suspicious transactions and keep customer information up-to-date.

In the European Union, legislation differs for fiat-to-crypto and crypto-to-crypto exchanges. Only exchanges that allow customers to trade between fiat and cryptocurrencies are required to implement KYC, while those dealing exclusively with cryptocurrencies are not.

However, in the USA, FinCEN treats all cryptocurrencies the same, necessitating that all exchanges conduct KYC and implement effective AML programs regardless of the currencies they support. As a result, many crypto-only exchanges restrict US citizens from accessing their services to avoid having to implement KYC processes.

Internationally, the Financial Action Task Force (FATF) is establishing standards for cryptocurrency anti-money laundering policies. FATF Guidance, while not legally binding, sets out rules for its 37 members, including the classification of exchanges and wallets as 'Virtual Asset Providers' (VASPs). VASPs are required to collect, store, and report data on transactions exceeding $1,000 in a single day.

As mentioned, to complete KYC processes on crypto exchanges, you typically need to provide personally identifiable information (PII), such as your full name, date of birth, address, social security number, and phone number or email address. Additionally, you may need to submit supporting documents, such as government-issued photo identification and proof of address. In some cases, you’ll take a selfie for biometric facial recognition systems or complete liveness detection tasks to prove your identity.

Why KYC Can Be Rejected

In certain instances, your KYC application might be denied due to various factors. One possibility is that the exchange does not cater to clients in your geographical area. If you are confident this is not the issue, it could be that there was a problem with the photos you submitted, your application lacked important information, or the verification of your address was unsuccessful. If you have recently relocated, this could be a contributing factor. It is advisable to contact customer support to seek assistance in getting your account approved.

Why Is KYC Mandatory

KYC is vital in the financial sphere as it helps combat the myriad of strategies criminals employ to dodge AML/CFT measures. Ideally, by developing an in-depth and precise risk profile for each client, crypto exchanges can spot and deter service misuse, as well as thwart crimes like money laundering and terrorist financing.

Let’s see why KYC is mandatory and theoretically beneficial for all involved parties:

  • KYC cultivates trust and openness with customers: User identity verification can bolster transparency and foster trust among customers. After all, when users are convinced that a crypto exchange is diligently protecting their accounts, they are more inclined to stick with the service.
  • KYC mitigates financial crime risks: Since 2016, there has been a steady uptick in cryptocurrency fraud. Research suggests that illicit crypto transactions reached approximately $14 billion in 2021, a 79% surge from $7.8 billion in 2020. These figures underscore the urgency for regulators to promote stringent identity verification and KYC procedures among cryptocurrency exchanges. Through the implementation of these protocols, exchanges can not only diminish the likelihood of financial crimes but also suppress fraudulent activities and boost their standing in the market.
  • KYC fosters stability within cryptocurrency exchanges: The crypto market is infamous for its volatility, which is partly driven by pseudo-anonymous, illegal transactions. Should cryptocurrency exchanges embrace KYC and customer verification methods, the market could stabilize, thereby increasing its overall value and enticing new customers.
  • Robust KYC policies pave the way for sustained compliance for businesses: As the legal landscape surrounding KYC compliance continuously shifts, many exchanges have grappled with adapting to these changes. However, those that effectively implement KYC policies are better positioned, enabling them to concentrate on enhancing conversion rates and optimizing transactions rather than scrambling to catch up.

KYC and AML in crypto

AML in the context of cryptocurrencies pertains to the legal framework, regulations, and strategies designed to hinder criminals from converting illicitly acquired digital assets into cash. KYC, or "know your customer," is a crucial aspect of AML, encompassing three key elements: customer identification, diligence in assessing risk, and continuous monitoring.

No KYC Crypto Exchange

Some individuals argue that enforcing KYC contradicts the decentralized ethos of cryptocurrency, asserting that exchanges should not demand personal information or documentation from users. Many consider it essential to keep their data concealed from authorities, particularly in countries with repressive governments.

There are additional reasons why some might want to evade KYC. For example, if a person owes debts to creditors, providing personal details to a crypto exchange could increase the chance of asset seizure.

Lastly, some individuals simply cherish their privacy and prefer not to disclose their information under any circumstances.

Some popular non-KYC alternatives include PancakeSwap, UniSwap, and dYdX. It is worth noting that while these exchanges do not mandate KYC, users might still need to provide personal details when withdrawing funds.

Also, if you’re looking to purchase crypto without KYC, there are several options.

For example, you can utilize peer-to-peer exchanges like LocalBitcoins or Paxful, or buy crypto with cash through an automated teller machine (ATM) designed for crypto transactions.

Alternatively, you can use a service such as ShapeShift or Changelly to convert one cryptocurrency into another without engaging in traditional exchange. These services, often referred to as decentralized exchanges, do not require users to submit personal information.

Some services, like Changelly, offer a mix of non-KYC and KYC options. For example, users wishing to conduct larger transactions will only be permitted to do so if they undergo the KYC process.

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So, what exactly is Bitsgap?

Bitsgap is a leading crypto trading platform that allows you to connect to more than 15 exchanges so you can manage your entire portfolio in one place. It doesn’t require KYC because Bitsgap doesn’t manage your funds but allows you to connect your exchanges to take advantage of tools most exchanges lack.

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Should KYC Be Cleared Only Once

It's true that customers must complete the KYC process for each crypto exchange they wish to use. Exchanges cannot share personal details with other parties for privacy and security reasons. KYC procedures also differ between exchanges. While repeating KYC for multiple exchanges may seem tedious, it is typically straightforward and manageable.

Is Know Your Customer Verification Safe?

Certainly, when interacting with reliable partner websites, it is safe. Each website ought to gather data via secure methods such as HTTPS and implement security precautions to safeguard customer information. However, exercise caution when sharing sensitive details like your social security number on dubious sites. Only entrust your personal information to websites with a solid reputation.

Can KYC Be Done Before Age 18?

In the majority of instances, it appears that you must be at least 18 years old to undergo the KYC process. This can be disheartening for younger individuals interested in trading cryptocurrencies, but there is an alternative solution. By acquiring cryptocurrency through a peer-to-peer service or a Bitcoin ATM, you can then trade it on a decentralized exchange that does not mandate KYC. Although this option may not be as convenient as using well-known exchanges, it remains a feasible choice for those unable to complete KYC.

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