What is Know-Your-Customer (KYC) in Crypto and Why It Matters

By Olayiwola Dolapo
10 Min Read

KYC stands for Know-Your-Customer. It’s a measure utilized by financial institutions to help identify their customers and assess their risk levels. Using KYC as a standard for verifying individuals’ identity became essential due to how convenient it was for fraudsters to go unnoticed after illegally looting or syphoning funds through financial institutions. 

In crypto, know-your-customer assumes a similar stance; the objective is to lower the rate of illicit activities due to the obscurity and anonymity affixed with trading and exchanging crypto by verifying and identifying customers.

The process was first introduced in the United States (US) and underwent a series of reforms before it became widely accepted. The idea was first initiated in 1950, and by 1970, the Bank Secrecy Act (BSA) was passed, which laid a foundation for other laws in subsequent years.

In 2001, the USA Patriot Act documented most of what led to the final version of the modern KYC. Exactly a year later, in 2002, KYC was made mandatory for all financial institutions (FI). While this explains the general introduction of an identity verification system, crypto exchanges became adherent to KYC and anti-money laundering in 2019 after FinCEN described them as money service businesses (MSBs) money transmitters.

Know-your-customer matters to non-custodial and centralized crypto exchanges as bad actors exploit the anonymity attached to using cryptocurrency to carry out illicit transactions. Know-your-customer and Anti-money laundering (AML) are implemented to decimate the actors using crypto as a cover-up.

In 2022, it was reported by the Federal Trade Commission (FTC) that over 46,000 individuals fell victim to crypto scams, resulting in a $1 billion loss between 2021 and 2022. With effective KYC implementation, the tendency for individuals to fall for this ill faith is reduced significantly. 

What Is KYC in Crypto 

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Know-your-customer are the requirement that crypto exchanges establish to acquire insight about a person during or after the onboarding process to become the company’s customer.

There are different approaches taken by crypto exchanges when it comes to its implementation. Some request immediate identity verification while signing up, giving customers complete access to the features and services. Other KYC-enabled crypto exchanges won’t demand verification at the onset or while signing up; instead, they limit access to some features of the company; usually, this can be restricting the maximum withdrawable amount, limited access to promotional offers, absence of margin or futures trade features, among others. Examples of such exchanges are Binance, Bybit, Kucoin, etc. 

Three major components form the KYC: the customer identification program (CIP), customer due diligence (CDD), and continuous monitoring; This creates a robust KYC scheme for any crypto exchange. 

Stages In KYC For Crypto Exchanges

Regardless of when the verification process begins—while signing up or afterwards— the required documentation requested from customers is the same for cryptocurrency exchanges across the board. 

Customer Identification Process CIP

Under the customer identification process (CIP), crypto exchanges ask for the customers’ name, date of birth, residential address, identification number and government ID, such as a driver’s license or international passport. CIP is the minimum requirement to asses a customer’s risk.

Customer Due Diligence (CDD) 

Customer due diligence (CDD) is a process which involves screening customers’ submitted details to verify their identity and their risk profile. CDD is of different types and is primarily subject to the customer’s risk level.

In scenarios where customers are observed to be low-risk, Simplified Due Diligence (SDD) is used; that’s, they don’t undergo the full CDD check that’s employed.

Enhanced Due Diligence (EDD) is employed when there’s a perceived higher risk from customers’ involvement in activities such as money laundering and terrorism financing. In this scenario, extra details are collected; a typical example is crypto exchanges requesting selfies from customers as a part of the user verification requirement. Not all customers are exposed to this phase of intense scrutiny from a crypto exchange. In specific situations, EDD is used when a customer is politically exposed. 

Ongoing Monitoring 

The process doesn’t halt at CIP or CDD; there’s a need to continue monitoring and accessing customers after onboarding must have been completed. This is the final stage of the KYC process, determining if the customers’ risk profile has changed. There are certain aspects to watch out for. 

  • Changes in the transaction amount by customers. 
  • Unusual transaction frequencies as previously observed.
  • Transaction between customers and sanctioned individuals or bodies. 
  • Adverse media screening. 

If the customer’s risk profile has changed — falling under the above conditions— the customer is reported to the appropriate authority, which is tasked with further investigation. 

The Benefit of KYC For Crypto Exchanges

There are quite several benefits attached to having KYC in a cryptocurrency exchange. While some argue that it defeats the anonymity of the industry, it’s important to understand the role of KYC in finance. 

In summary, KYC implementation by financial institutions (FI) such as crypto exchanges places a massive barrier for criminals. Otherwise, it will be a dump site for most criminals and an escape route. Here are some benefits of implementing KYC for crypto exchanges: 

Reduced Tendency for Crypto Crimes

The nature of cryptocurrency set it up as a tool for criminals to hide under the curtains. That’s the irreversible transaction (crypto sent out can’t be reversed); the anonymity, meaning there’s no way to identify the individual carrying out a transaction; these factors, among several others, make crypto a playground for illicit activities.

Appropriate implementation of a robust verification scheme by cryptocurrency exchanges will reduce the tendency for crimes conducted in space. Bad actors will gradually begin to flee the space due to the enactment. 

It’s said that Bybit, a centralized crypto exchange, is expected to tighten its verification process, limiting the features users without KYC can access on the platform.

The tweet also advises users to switch to an alternative crypto exchange .

Adding More Transparency & Legitimacy to The Space 

Transparency is an important facet of cryptocurrency exchanges that plan on building and facilitating trust among their potential customers and customers.

With the inclusion of KYC by crypto exchanges, there is an increase in customer confidence in the exchange. Customers can rest assured that the exchange doesn’t facilitate or support the use of cryptocurrency for illegal activities such as terrorism financing. 

Even recently, to boost customers, potential customers, and investors’ confidence, certain cryptocurrency exchanges implemented proof-of-reserve, revealing the digital assets said exchanges have as collateral. 

Bottom line

No one can undermine the benefits of crypto exchanges implementing KYC as it adds an air of legitimacy to the space. Although not every country is strict on KYC implementation by crypto exchanges, the space will experience more strict regulation while others embrace its adoption as time passes.

Frequently Asked Question

Do I need KYC to Buy Cryptocurrency 

The answer depends on the types of crypto exchange you choose. Centralized crypto exchanges such as Binance and Coinbase require you to complete KYC before purchasing or using most of its platform features. Decentralized or peer-to-peer crypto exchanges don’t require KYC before making any purchase. 

How Long Does Crypto KYC Verification Take?   

If the appropriate documentation is provided as requested by the KYC exchange, verification can take a few minutes or hours; however, sometimes, it might extend a few days. 

Doesn’t KYC Defeat The Purpose of Anonymity in Crypto? 

KYC implemented by non-custodial centralized exchanges doesn’t support anonymity to a great extent. However, if you prefer anonymous trading, consider decentralized exchanges which supports peer-to-peer trading mostly. 

What Are the Best KYC Cryptocurrency Exchanges? 

There isn’t a best KYC cryptocurrency exchange to trade with; it’s utterly subjective to you as a customer. You might prefer the services and features of exchange A over exchange B, and it’s the opposite for another person. 

After losing his DOGE tokens due to a limited understanding of blockchain technology, Dolapo made a pledge to explore its vast potential. Now, as a dedicated writer, he sheds light on the intricacies of this innovative technology for others. Dolapo distinguishes himself with his expertise in marketing.