KYC/AML Compliance in Crypto Industry - Introduction for Business Owners

Improved financial technology has eased money transfers by leaps and bounds in recent years. This has undermined the security measures and laws implemented by regulators and law enforcement agencies to prevent illegal transactions. According to a report, the U.S. banks have handled over $2 trillion in suspicious transactions.

The advent of cryptocurrencies has made both local and international transactions even more effortless. Due to this, regulators have grown highly skeptical of cryptocurrency transactions. They are extra cautious while assessing and approving companies operating in the blockchain and cryptocurrency space.

“Know your customer” (KYC) and “Anti-money laundering” (AML) regulations have played a crucial role in reducing illegal transactions through both traditional systems and cryptocurrencies. More than ever, cryptocurrency companies need to strictly abide by these regulations to prevent any legal consequences. Global AML regulation is heavily influenced by the policies that shape the United States’ approach to money laundering and terrorist in crypto arena.

This article takes a closer look at what KYC/AML requirements are, explain why it is important to meet these regulations and presents the list of companies providing such services. The terms presented in this blogpost aim at businesses planning to build their crypto products or services, such as crypto exchanges, trading platforms, digital wallets, crypto apps, and many more.

Outline

Know your customer (KYC) is the process cryptocurrency companies, or any payment service provider for that matter, need to enforce in their operational process to verify the identity of their customers.

For example, a cryptocurrency payments platform must require all its users to upload their identification details before creating their complete profile. These details may include:

Full name
Phone number
Residential or physical address with a proof
Copy of national identity document or passport
A portrait with the ID proof or a selfie video

WireX is one such platform that verifies its users by asking for an identification document such as a passport along with a video recorded within the application. The platform uses the video and the uploaded document to cross-verify if the identification provided by the user is legitimate.

At the foundational level, cryptocurrency users do not require to reveal their identity to anyone for transacting any amount of money. Even the transactions are recorded in an encrypted manner, keeping the transacting parties anonymous.

From a legal perspective, this may have severe repercussions. It may open doors for many illegitimate activities that lawmakers have tried hard to suppress all this time.

Implementing KYC procedures helps the companies identify their users in case of any suspicious transactions.

Anti-money laundering (AML) is an all-inclusive legal term that refers to the set of rules and procedures followed by entities to recognize and prevent illegal transactions and terrorism financing. Many money launderers even follow methods that are designed to make illegitimate transaction may look legitimate. AML laws and procedures aim to detect and curb these activities.

Hundreds of millions of dollars are laundered every year. So far, banks have been a major medium for launderers to launder funds beyond borders. Regulators fear that cryptocurrencies can be the next big financial instrument for laundering money anywhere in the world.

This is because of two major reasons:

Cryptocurrency transactions are anonymous
Cryptocurrencies do not necessarily need a centralized financial institution to process the transactions

As money laundering often includes transactions made between several nations, there are international AML regulations to tackle such situations. The Financial Action Task Force, or FATF, is the global AML regulator that outlines and updates international standards for member nations to fight money laundering and terrorism financing worldwide.

More specifically, in the world of cryptocurrencies, AML refers to the tracking and tracing of blockchain transactions and building cyclic graphs to identify the movement of money. Based on the obtained data, such solution providers identify where and how the funds are moving.

Elliptic monitor transactions, detects and visualizes the transaction flow. The graph below was created to gasp the idea of how risk monitoring works. Each circle is a representation of a bitcoin address. Various colors show to what extent the funds have been diluted by bitcoins from other sources where red means receiving scam funds and yellow means receiving bitcoins from other sources too. Numbers represent the amount of cryptocurrency that has been sent to the proper address.

The datasets also distinguish transactions based on several factors and mark them as low, medium, high, or severe-risk transactions. Chainanalysis distinguishes the following risk levels of a category or a service:

Source: Chainalysis.com

This process allows crypto exchanges or service providers to take necessary actions whenever high or severe-risk transactions come through on their platform.

It can be said without a doubt that all financial institutions and companies either providing direct payment services or other forms of financial services need to be KYC/AML compliant. For a financial institution of any size and form, such compliance have been made mandatory by governments.

Know your customers and anti money laundering compliance is all the more critical for crypto organizations as they are strictly under the microscope of regulators. And the slightest failure to comply with these laws may lead to legal consequences for the owners of the company.

As AML and KYC verification is not an easy process, companies need to pay a substantial amount to solution providers. However, the cost of not complying with the laws may prove even more expensive.

Crypto exchanges form a major part of the crypto industry. On the day of writing, the total cryptocurrency trading volume on all crypto exchanges globally exceeds $122 billion.

As cryptocurrency exchange platforms facilitate such huge amounts of trade, there’s a terrific opportunity for bad actors and money launderers to launder huge sums without anyone noticing. But that is only possible if an exchange platform does not have proper compliance solution integrated into their exchange portal.

Crypto exchange that comply with regulations may easily detect suspicious transactions and trace the funds back to its users. They may then identify the customers using the KYC details submitted by them.

This will not only help crypto exchanges promote more legal activities using cryptocurrencies but also enable regulators to hold accountable the people involved in illegal transactions. Besides, if the compliance program of crypto exchanges is implemented, they have a better chance of building trust both in their platform and in the crypto arena.

In 2019, FATF introduced the Travel Rule for virtual asset service providers (VASPs) in the United Kingdom and across the world. Besides, the European Union introduced the Fifth Money Laundering Directive while the U.K implemented its own version of the directive after parting from the EU.

Before these directives, much of the crypto organisations and financial institutions fell in the grey area of money laundering regulations. With the new directives, crypto firms in the U.K. are now subject to money laundering regulations within the country. As part of the KYC process, the crypto firms in the U.K. must at least obtain from their customers:

their full name,
a copy of their ID along with the date of birth, and
a residential address proof

Similar regulations are being formed throughout the world after FATF put out the Travel Rule and brought it into play this year. While many countries are still far behind in terms of creating a full-fledged regulatory framework for cryptocurrencies, progress is evident all over the world.

As KYC process mostly remains the same even in the case of crypto platforms, most KYC companies in this space are commonly found across other sectors. AML companies for crypto, however, follow a completely different approach as they have to deal with anonymous cryptocurrencies transactions on the blockchain. So, most crypto AML service providers have specifically designed their services to serve the blockchain and crypto space.

Here’s a list of companies that have crafted their solutions for cryptocurrency companies:

If you want to learn more about these AML companies, read our best AML software comparison.

It is important to understand that if cryptocurrencies are to become a mainstream form of currency, next to fiat currency, regulations are inevitable. We saw the crypto frenzy in 2017 and hundreds of scam projects looted millions of dollars from users who were still new to the cryptocurrency space. That was the time when most people lost trust in cryptocurrencies.

Thus, regulations enforcement may benefit the cryptocurrency industry to win the trust of more people. It will boost legal activities while minimizing illegal trade and exchange of cryptocurrencies.