The cryptocurrency industry has undergone some significant change over the past few years. One of the most prominent has been with security. When it became evident that cryptocurrencies were here to stay, everyone quickly became aware of how they worked, with the hope that they could benefit from the assets and become even richer down the line.
However, the increase in adoption also turned cryptocurrencies into a target. Hackers understood their worth and were willing to risk it all to get their hands on digital assets. What followed was a wave of attacks and security breaches that affected pretty much every top exchange.
There have been quite a lot of hacks in the crypto space. From Mt. Gox and Bitfinex to Coincheck and Binance, even the top names have seen themselves fall victim to hungry hackers in their pursuit of more gains and funds. So, it became necessary that improved security infrastructure needed to be built if the industry was to survive.
KYC Emerges as a Necessity
Beyond the significance of security for preventing security breaches, there was also a need for improved identity verification as exchanges became more viable. Calls for regulation have been prominent over the past few years, and there is now hope that the industry could gain some traction.
However, regulators and governments have hammered on the need for adequate identity verification if the crypto industry hopes to gain their favor. All in all, exchanges would need to keep records of their users and the people who make transactions via their platforms. Anti-Money Laundering (AML) and Know-Your-Customer (KYC) soon became the solution.
In its simplest terms, KYS is a set of compliance processes that financial institutions use to get information about their customers - especially new ones coming in. The information obtained will allow companies to verify customers' identities and help prevent issues like terrorism financing and money laundering.
For instance, customers will need to provide their identification credentials before making transactions on these platforms.
KYC can be classified into Customer Due Diligence (CDD) and Enhanced Customer Due Diligence (ECDD). While CDD comes into place when authenticating new customers, ECDD includes additional checks for high-risk clients.
Integrating KYC Into the Crypto Space
As explained earlier, KYC became necessary for the crypto industry after the push for regulation became prominent. Before then, cryptocurrencies had been entirely unregulated, and the market was overly dangerous.
The former operation was beneficial for hardcore crypto enthusiasts because it allowed them to protect their anonymity. This anonymity, coupled with the fact that digital assets are decentralized, made the crypto industry lucrative for some top decision-makers.
Still, increased popularity means that regulators had to be more careful when approaching the industry, and KYC became one of the best ways for them to do so.
For most crypto exchanges and asset custodians, KYC processes have been relatively different from those in the traditional financial space. The most significant difference is that exchanges conduct KYC checks after users sign up for their services. Even at that, not every exchange conducts KYC cheeks. Some of them employ tiered systems, requiring that users provide additional identity verification details before they can deposit or withdraw a certain amount of digital assets.
Even at that, some of the processes that crypto exchanges operate include the following:
- Zero KYC: The user can sign up without completing any KYC checks. However, they won't be able to withdraw and will be limited to a few functionalities alone.
- Basic KYC: The user uploads some identification documents (such as photo IDs) and can only deposit and withdraw a limited amount of funds at a time.
- Full KYC: The user completes the entire KYC process and can enjoy access to the exchange's full suite of features - including maximum withdrawals and deposits.
Arguments Abound in the Crypto Exchange
For many in the crypto industry, the introduction of KYC checks was a step in the right direction. If anything, they represented an evolution and showed that crypto companies could be held to the same standard as those in the traditional finance space.
However, some hated these new checks. For these people, surrendering your anonymity basically goes against everything that the crypto industry stands for in the first place.
There was also the fact that some countries have implemented overly stringent identity verification checks. In 2018, the European Union implemented the Fifth Anti-Money Laundering Directive (AMLD5), which outlined AML and KYC policies that financial institutions across the continent should take. However, crypto exchanges in the Netherlands were against this implementation. For one, they took issue with the Dutch National Bank (DNB) after it seemed like the regulator was deliberately trying to stifle them.
In a letter to the Dutch parliament, Daan Kleiman, the CEO of local exchange Bitonic, asked for the rules to be abolished in their entirety. Interestingly, Bitonic eventually agreed to implement KYC checks last year.
In truth, one of the most common misconceptions about KYC is that it challenges cryptocurrencies' decentralized nature. However, this isn't entirely true. Instead, these checks just help with tracking transactions and providing a way to ensure that digital assets aren't being used for illicit purposes.
For now, the arguments over KYC's place in the crypto industry continue to rage. However, the fact remains that these policies and checks are here to stay. There is no way the industry survives without some significant checks that keep transactions safe. These policies themselves will be required if there is ever to be a hope of cryptocurrency regulation in developed markets.
As long as cryptocurrencies exist, there will always be people looking to exploit them for harmful applications. KYC helps to reduce that, at least - if not eradicate it entirely.