What Is KYC, and Why Is It Required for Crypto Exchanges?

LBank Exchange
4 min readJan 24, 2023
What Is KYC, and Why Is It Required for Crypto Exchanges?

Every institution loves to know its clients and how they can consistently improve their services to give them better functionalities. Usually, the process revolves around collecting users’ data to track and avoid potential theft, fraud, money laundering, and terrorist financing. With KYC, financial institutions and banks are able to identify their users.

Although KYC had been introduced to many countries’ financial institutions, it was initially recommended for companies and not mandatory. It was only after the 9/11 terrorist attacks on the World Trade Center and Pentagon that it became a mandate for many countries.

Corporate scandals which had reached new heights were also exposed. It was clear the role played by dirty money or laundered money was very influential in local and cross-border crime and terrorism. The need to discourage and attempt to cut down these exploitations of worldwide financial services and systems became most urgent. From that time onwards, it has been done by a procedure called KYC, and a similar concept has rubbed off on the newly booming blockchain technology. Ultimately, this guide will focus on KYC and AML compliance in the cryptocurrency space.

What is KYC?

In simple terms, ‘Know Your Customer’ KYC is a term used to simply identify the users and collect required information before they begin their investments. It is a must for all investors and applicants to understand the norms and rules for the same. ‘Know Your Customer’ is a security measure that involves companies collecting personal details from users to identify them.

Some of these details include:

  • Email Address
  • Phone Number
  • Copy of government-issued ID (Driver’s License, Passport, SSN, etc.)
  • Proof of residency (utility bill, bank statement, etc.)
  • Selfie Holding ID
  • Biometrics (fingerprints, other unique identifiers)

KYC in Cryptocurrency

As the popular saying goes, “A rising tide lifts all boats.” Unfortunately, a rising tide can also lift bad boats. With the increasing popularity of cryptocurrency, the rate of theft and fraud have also increased.

KYC in cryptocurrency has two main objectives:

  1. The first mission is to combat illegal activities using Bitcoin and other crypto assets. Since crypto transactions are decentralized and anonymous, criminals are finding it easy to move funds worldwide and distribute them across different accounts to hide their illicit profits.
  2. Additionally, KYC in crypto companies is to ensure users stay compliant and protect them from tax avoidance. As new laws and regulations are being passed across, governments are exploring several ways to ensure eligible users pay taxes, and KYC is a good way for them to trace compliant taxpayers to their crypto wallet.
  3. Ultimately, KYC is one of the many compliance tools to help crypto exchanges navigate through various regulatory scenarios. But doesn’t KYC affect the anonymity and decentralization features of blockchain? Keep on reading; you’ll find out.

‍What Does KYC Mean in Crypto Exchanges?

For crypto exchanges, crypto KYC compliance simply means that ‘traditional’ KYC is being used to tackle certain challenges that crypto exchanges face with these controls.

Risk-based compliance: Risk-focused compliance requires crypto exchange platforms to perform risk assessments of users and employ proper AML/CFT measures. The rule of thumb is if an assessment procedure shows that a client is a high risk, the exchange platform will use more solid compliance measures — different from simple measures for low-risk users.

Customer monitoring: With KYC tools, exchanges are able to track and monitor users’ transactions on a consistent basis, assessing different signs of criminal activity — which may include fraudulent patterns or transactions involving high-risk users.

Screening: Additionally, KYC also involves exchanges to screen users to ensure that they are not exposed to international sanctions or users involved in money laundering.

What are the benefits of Crypto KYC?

While steady operational rules are constantly being updated when using KYC standards, cryptocurrency exchanges enjoy some regulatory compliance for the following reasons:

  • Improved market stability

Reduction in fraud, thefts, and crypto scams will definitely affect the psychology of the market. KYC is a good market sentiment tool that favors the overall stability and growth value of cryptocurrencies.

  • Minimizes legal risk

Since KYC processes enable VASPs to prevent fake identity instances and money laundering and enable easy access to customer risk with the provided government-issued identification, it will definitely keep exchanges outside the matrix.

  • Improve trust among users

Verifying user identities boosts transparency and trust among customers. When users are rest assured that their cryptocurrency exchange platform is serious with various preventive measures to safeguard their accounts, more users tend to get attracted.

  • Mitigates money laundering and frauds

The ability to trace transactions for money laundering purposes is also important and can help reduce fraud, which protects both the users and exchanges. Virtual Asset Service Providers (VASPs) put out suitable policies combined with relevant tools to stop money laundering (ML) and thefts.

Overall, with more rules and regulations rolling in, crypto compliance becomes more and more essential, and crypto platforms dealing with digital assets must be able to absolutely depend on AML compliance tools and services to help them navigate through various regulatory scenarios.

Does KYC Affect Anonymity and Decentralization?

Although a lot of people see KYC compliance as the enemy because, apparently, it goes against the innate features of anonymity and decentralization of Bitcoin, the truth is it’s highly needed to push crypto to the mainstream. Without having records of users, crypto exchanges may eventually be a gateway for hackers, criminals, and scammers to have a field day.

On this principle, many would agree that submitting their identities will facilitate the growth of blockchain and crypto.

Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.

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