As of early 2022, illicit addresses were holding an estimated US$10 billion in cryptocurrency. With internet-savvy criminals looking to wash funds and profit from scams, crypto-to-crypto and crypto-to-fiat exchanges must work hard to prevent people from using their platforms for ill intent purposes. To that end, KYC procedures are an integral part of risk management and compliance for companies in the cryptocurrency space. What is KYC? How does it affect crypto exchanges? Keep reading to find out.
Know Your Customer processes refer to the procedures and standards used by businesses to protect themselves from being used to commit fraud, launder money, or finance terrorism. Crypto exchanges have two strong reasons to have KYC procedures:
1. Government regulators
2. Risk and reputation management
In 2021, the Commodity Futures Trading Commission handed BitMex a $100 million fine. The press release revealed that the trading platform had failed to implement anti-money laundering (AML) and Know Your Customer (KYC) procedures.
However, government regulators haven't always stopped at fining companies. BTC-e, a former crypto exchange, was shut down by the Department of Justice amid accusations that the exchange had been used to launder up to $4 billion.
Now more than ever, AML, KYC, and Combatting the Financing of Terrorism (CFT) compliance are necessities for crypto exchanges.
When it comes to KYC, crypto exchanges face multiple industry-specific hurdles. Here are some key considerations for crypto exchanges that are revisiting their AML/CTF compliance measures:
1. Anonymity Cryptocurrency users and wallets are often anonymous by design. As a result, it's all too easy for bad actors to operate out of countries with negligent financial regulations or circulate funds through third parties. These facts make crypto exchanges a prime target for people with fraudulent intentions.
2. Transaction Speeds Thanks to the speed of blockchain technology, transactions can be completed in seconds. When it comes to crypto KYC, vintage assessment methods may not be enough. Exchanges will have to ensure that their KYC measures are capable of real-time transaction monitoring.
3. Risk-Based Compliance The Financial Action Task Force recommends that businesses adopt measures that reflect a proportionate response to the actual risk posed by a client.
This is known as risk-based compliance. In the cryptocurrency space, users may require additional scrutiny. If that happens, Enhanced Due Diligence reports and varied layers of security may need to be assessed and considered.
After getting a high-level understanding of KYC and its implications, crypto exchanges will need to embed AML and KYC measures into their regular processes. Some steps to this end include:
Regardless of the exact tools used when dealing with clients, exchanges will need to monitor accounts and transactions on an ongoing basis. If accounts are compromised or a user is later revealed to be a politically exposed person, the exchange should be ready to respond.
More than businesses in other sectors, crypto exchanges have to pay special attention to AML/CTF compliance standards. A robust set of KYC procedures can help crypto exchanges protect their reputations, avoid fines, and deter criminals.
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