Know your customer (KYC) refers to the process used by institutions to verify the identity of their customers. It is also used to assess risk factors for money laundering and combating the financing of terrorism (AML/CFT), to fight financial crime. The objective of KYC is to confirm that customers are who they say they are and that they are not involved in criminal activity. KYC procedures are mainly mandatory for financial institutions. Such controls serve to increase confidence in the industry and help financial service providers manage their risks. KYC processes have become very common on cryptocurrency exchanges. What is KYC? (Know your customer)

 

What is KYC? (Know your customer)

 

If you have opened an account with a cryptocurrency exchange such as Latamex, it is likely that you have had to complete a KYC check. Upon completion of this process, the user may be asked to provide a national identification document, passport and/or driver’s license. What is KYC? (Know your customer) 

 

There are likely to be several levels of KYC and the user may also need to confirm their address in addition to verifying their identity. Financial service providers may also need to periodically reconfirm the identity of their users on a case-by-case basis. What is KYC? (Know your customer) 

 

What is its origin? 

 

In Europe, the fourth Anti-Money Laundering directive (AML4) came into force in mid-2017, with a set of rules for financial institutions to protect themselves against these threats.

 

Among these new obligations introduced by this AML Directive, there is the duty of financial institutions to control the identity of former and future customers. On the one hand, they must carry out a formal identification of customers by presenting the DNI, passport and NIE (Foreigner’s Identity Number) for foreign customers, as well as the NIF (Tax Identification Number). On the other hand, they are obliged to know that this is the person opening the account.

 

Thanks to the increasingly frequent use of the Internet and new technologies for consultations and transactions, this personal identification has become one of the most effective measures to avoid online fraud.

 

Why are such procedures needed in payment systems across the board? 

 

Over the last decade, we have seen constant consumer fraud through phishing, data breaches, identity theft, money laundering and other digital frauds, which have increased even more in recent times. 

 

Corporate losses from fraudulent online transactions are estimated to reach $25.6 billion dollars by 2020, according to Juniper Research. The Intergovernmental Financial Action Task Force (GAFI) estimated that revenue generated by organized crime and drug trafficking accounted for 3.6% of global GDP. Therefore, financial institutions must employ KYC processes to reduce fraud and protect the reputation of their brands. In addition, in several countries it is required by law to know your customers. 

 

Who regulates KYC compliance? 

 

KYC regulations differ from country to country, but there is international cooperation on the basic information required. In the US, the Bank Secrecy Act and the Patriot Act implemented most of the AML (Anti-Money Laundering) and KYC type processes we see today. The EU and Asian countries have developed their own regulations, but these largely overlap with those of the U.S. The EU’s Anti-Money Laundering Directive (AMLD) provides the main framework in EU countries. At the global level FATF – as we saw above – coordinates multinational cooperation on regulatory conditions.

 

Anti-money laundering 

 

Anti-money laundering measures are a set of laws, procedures and regulations created to stop the practices of generating income through illegal activities. Some of these include market manipulation, tax evasion, trading in illicit goods, misappropriation of public funds and other such activities. AML regulations require financial institutions to continuously perform the indicated procedures to detect and prevent malicious activities.

 

Fighting against the financing of terrorism 

 

Counter-terrorist financing refers to the set of procedures designed to investigate, deter and block sources of funding for activities that carry out actions through violence, or the threat thereof, against civilians. These procedures provide law enforcement agencies with an alternative and potentially effective way of tracking and blocking terrorist activities.

 

Why do we need KYC in crypto?

 

Cryptocurrencies have been used for laundering illicit funds and tax evasion at times. By improving their regulation, we positively impact their reputation, which in turn generates a higher level of adoption in the long run. There are three fundamental reasons why KYC controls are necessary in the cryptocurrency industry:

 

• Transactions on the blockchain are irreversible, which means that funds can be stolen or transferred and cannot be retrieved
• Cryptocurrencies are fairly anonymous (pseudonymous, as it is not necessary to provide any personal information to open a wallet).
• There is still some uncertainty regarding taxation and regulation of cryptocurrencies in several countries. 

 

Crypto KYC Processes 

 

The KYC process is generally divided into four levels: 

 

• Customer acceptance policy (CAP), which is the stage at which a company determines and documents the demographics of its desired customers 
• Customer identification program (CIP), which is the stage at which the company confirms that a (potential) customer’s identity matches its CAP
• Continuous monitoring of transactions to ensure regulatory compliance and identification of suspicious activity
• Risk management

 

What are the advantages of the KYC process? 

 

• Lenders can more easily assess their risks by determining a customer’s identity and financial history
• Combats identity theft and other types of financial fraud
• Reduces the risk of money laundering situations at source 
• Improves the security, trust and accountability of financial service providers. This has a ripple effect on the financial industry as a whole and can encourage investment What is KYC? (Know your customer)

 

Arguments against KYC

 

The KYC process has a good number of advantages, as we have discussed above, but it remains somewhat controversial to its critics. Some of the criticisms are: 

 

• There is an extra cost associated with running KYC checks, which is sometimes passed on to the customer through commissions
• Some people do not have the required documentation or do not have a fixed address, which makes it difficult to access certain financial services when the aim is precisely to democratize them
• Irresponsible financial service providers may lack security in data management, and users’ private data may be stolen in a hack
• Some argue that KYC processes are contrary to the decentralization of cryptocurrencies

 

Conclusions What is KYC? (Know your customer) 

 

KYC processes are a standard for financial services and also cryptocurrency exchanges and, as the evidence points out, it is one of the most important functions in the fight against money laundering and other crimes. KYC controls may seem cumbersome for users and also decentralized, but they bring a lot of security.