What is KYC? Know Your Customer Process Explained
KYC stands for Know Your Customer. KYC is a verification process used during transactions to confirm a customer's identity. This process is done mostly for security and regulatory purposes.
KYC is not exclusive to cryptocurrency transactions. You’ve encountered it if you’ve opened a bank account, signed a cellphone contract, or opened a credit card in the US.
The process has been in place since the implementation of The Patriot Act of 2001. As a byproduct of the 2001 act, it was intended to better national security. It works like this.
Financial institutions work with governmental agencies using data provided by the customer. The data provided is then put into a database that runs the potential risks of doing business with that customer. The databases hold information that would flag customers with negative marks. This process is in place to prevent money laundering, terrorism funding, and other nefarious activities. KYC also helps to address the financial risk of doing business with a customer.
What’s the difference between AML and KYC?
KYC is like the AML (Anti-Money Laundering) process. AML is a regulatory standardization that has been around a little longer than KYC. AML and KYC are very similar. The distinct difference is that KYC verifications aim to identify the risk of doing business with that customer.
What You Need To Complete KYC Verification
Generally speaking, KYC is a requirement that you share a photo of an official government-issued ID, Passport, or Driver's License. Submission of a photo of yourself is also necessary. The photo is then compared to the ID submitted.
Sometimes part of the verification process is submitting a photo of yourself holding an ID. Some verifications even ask for a photo of the customer holding a piece of paper with a short phrase that is handwritten. The verifier will give you the phrase that is to be written. This phrase will often include your name and the date. This technique helps verify that the person submitting the KYC is not falsifying documents or photos.
Again this is a generalization since every website/app can be different. The videos below are from the crypto exchanges; Celcius and KuCoin's support websites. These are generally what you can expect a KYC verification process to look like on a typical exchange.
Tutorial - Individual KYC Verification On KuCoin
Who Regulates KYC?
KYC, AML, and similar regulatory systems are of national and international origin. This means that there are several bodies to standardize and regulate KYC verifications globally. Every country has its own regulatory body that handles the verification and regulation of AML, KYC, or whatever system they have in place. Some places have multiple governmental bodies or use privatized organizations to handle verifications.
For example, SWIFT is a large organization involved in handling international financial transactions. On its website, SWIFT provides a list of who sets standards, handles the verifications, and regulates KYC.
- US Department of State sanctions lists
- Specially Designated Nationals and Blocked Persons Lists (SDN)
- Financial Action Task Force lists (FATF)
- Transparency Index lists from Transparency International
- State Sponsors of Terrorism list"
How crypto companies are adapting to KYC
Cryptocurrency’s credibility has been a point of contention from the beginning. There are many arguments for and against the security, education, and widespread adoption of crypto. These go for crypto companies, customers, and government agencies alike. Recent media coverage and its global adoption have propelled the growth of crypto, too.
Still, there are lingering issues of security and credibility that hinder the industry’s growth. Investors, consumers, traditional financial institutions, and government agencies alike agree on at least one issue- crypto needs more clarity in regulation.
Crypto companies and organizations are making multiple solutions to the issue of clarity. For example, Shyft Network is a blockchain-based protocol that is working towards crypto compliance. They are building the infrastructure for all crypto customers to get KYC verification.
Shyft addresses this dilemma below:
“As the popularity of Defi grows, the threat of regulation will always linger, and facing it head on is the best way to deal with it. Our goal is to create a massively-adopted, compliant, and scalable DeFi ecosystem with comparable market depths across centralized and decentralized markets.”
In order to establish standards, it will take work from lawmakers and crypto companies together. Bridging traditional financial regulations with new and fundamentally different technology is a Herculean task. Shyft addresses this problem with possible solutions on their website. Here they explain why this could be a difficult process.
“Large Liquidity Providers (LPs) often cannot interact with the Defi space because of regulatory constraints and lack of clarity. Similarly, platforms within the Defi space can't explore funding potentials because of the small opportunity space relative to the total potential addressable market assuming regulatory compatibility. Having seen no guidance from the Defi ecosystem, regulators must comprehend the sector through the lens of potentially obsolete and irrelevant past environments to which regulations were applied.," states Shyft's website.
ISO (International Organization for Standardization) provides a visual roadmap of compliance standards. These standards might optimize the adoption of digital assets by regulated institutions ISO also aims to protect the consumer as well as institutions from potential threats. There is a larger focus on International transactions - this is due to advancements in technology that lead to international business growth.
Criticisms of KYC
The major issue with the KYC process and crypto is that crypto, by design, is supposed to be decentralized. The nature of KYC, standardization, and regulation, is the exact opposite of decentralization. Yet, it is understood by major trading platforms, such as Binance, that KYC is necessary for the growth of the crypto industry. Even if it does go against the decentralization aspect. It is crucial, at this stage of the ‘gray area’ in crypto, for centralized exchanges such as themselves to comply.
"For users concerned with the ethos of anonymity via decentralized blockchain, losing anonymity is a high price to pay especially when they submit their KYC details to centralized cryptocurrency exchanges. While cryptocurrency exchanges promise to treat users' private information with care, many people who prefer to maintain anonymity don't want to take that chance. These fears are not unfounded since many exchanges still do not have robust KYC systems to secure consumer information,” writes Binance on the importance of KYC in crypto.
Important Concepts to Take from KYC
There are potential risks and benefits that come with the regulation of the crypto space. As much as people enjoy their privacy, it is understood that what crypto needs is regulatory clarity and standardization. It is often considered to be the largest issue hindering its growth. KYC may help to reduce some of the uncertainty in the market. This is because KYC is a step in the direction of standardization and security. Companies would have more room for growth. They could operate free from the fear of pushing legal boundaries. This same comfort is felt by the consumer - knowing that any capital put into crypto is deemed legitimate makes crypto feel more secure.
The same argument could be used against KYC regulation in the crypto space. People against the standardization and regulation of crypto would argue that KYC threatens its decentralization, privacy, security, and censorship resistance aspects. This would move crypto in the opposite direction of the core principles that birthed it. The privacy and anonymity of crypto remain appealing attributes for a large part of the community. People are drawn to the ideology of regaining control of their assets.
Regardless of your preference, the most important thing to remember is to always protect your personal information. It is your responsibility to be diligent in researching the legitimacy of a space where you are prompted to enter personal information.