Friday, October 7, 2022

What is Know-Your-Customer (KYC)?

Financial institutions check their customers’ identities using a set of criteria termed Know Your Customer (KYC). Cryptocurrency exchanges, on the other hand, fall behind traditional banks in terms of implementing KYC rules. 

The government is pushing for KYC implementations in order to track down unlawful monetary deals and further authenticate each and every transaction as it relates to blockchain technology. Based on the obvious benefits it offers, it is quite becoming a necessity for exchanges to adopt KYC just like banks.

What exactly is KYC? 

Know Your Customer (KYC) practices are used by financial institutions and cryptocurrency exchanges to identify and assess the risk profiles of customers. This can be confirmed by asking for identification, such as a driver’s license, home addresses, passports, any other government-issued ID cards, or a utility bill. This type of verification reduces activities of money laundering and the support of terrorists. 

Every country in the world has legislation and standards in place to ensure that businesses can conduct their operations in a secure manner, with regulatory agencies like anti-money laundering directives (AMDLs) in Europe and FinCEN’s Financial Crime Enforcement Network’s rule in the United States, having varying standards. 

There are a variety of reasons why crypto exchanges mandate the KYC

In the event that crypto exchange has access to a user’s Know Your Customer (KYC) information, it can conduct criminal background checks to determine whether or not the wallet is being used for illicit reasons. Major reasons include;

  • General Identity Verification 

For online applications that require identity verification, it is becoming increasingly common for these applications to include automated identification verification. Potential Bitcoin investors are unable to submit their documentation by conventional means due to the nature of cryptocurrency exchanges.

Instead of conducting in-person identity verification, third-party services allow users to submit their identification documents, such as passports, along with a self-portrait taken with a smartphone. Biometric mapping technology can be used to compare the images on an applicant’s identification card to those on his or her passport.

  • Mitigation of crime and tax payments 

A major source of concern in the cryptocurrency space is money laundering and other illegal financial transactions. As the name implies, a pseudonymous account is one that has been created with fictitious information, such as a nickname or other incomplete information. One type of criminal activity made possible by pseudonymous transactions is “ransomware,” which is a method of extorting funds by preventing a person’s or business’s computer systems from functioning until a fee is paid.

The implementation of KYC procedures helps mitigate the risks of accounts being used to either commit fraud or launder money.

The KYC process

The Know-Your-Customer (KYC) system is governed by law and regulations, which establish the principles of the process. Typically, companies in the financial services and banking sectors are subject to the most stringent requirements for Know Your Customer (KYC) documentation. 

With the digitization and automation of the KYC process, several methods or technologies such as artificial intelligence, security features (such as holograms), and other security checks are now being used in the verification of the KYC process (e.g., biometrics).

It is necessary to check for any inconsistencies in the veracity of a person’s government-issued identification paper before proceeding. Face verification checks are performed in order to prevent spoofing attempts and to ensure that the customer is truly present at the time of the transaction. 

Obtaining a Proof of Address (POA) verifies that the address on government-issued identification documents matches the address on the POA.

Does KYC pose a danger to anonymity or decentralization?

The popularity of blockchain and cryptocurrencies can be attributed to their decentralized character, as no single authority has ultimate control over the system.

In contrast to traditional databases, transactions on blockchains are stored on a worldwide network of peer-to-peer nodes running on a broad variety of computers rather than in a single database. Because KYC requirements delegate authority to a centralized authority, Bitcoin exchanges are analogous to traditional financial institutions in this regard.

When it comes to decentralized blockchains and the ethos of anonymity, the loss of anonymity to central cryptocurrency exchanges is a significant cost for consumers who are worried about their privacy. Many people who cherish their anonymity are wary of transacting with cryptocurrency exchanges, despite the fact that they claim to preserve their users’ personal information.

These reservations are based on the fact that many exchanges still do not have effective Know Your Customer (KYC) protocols in place to protect consumer data. Hackers have gotten access to bitcoin users’ Know Your Customer (KYC) information by taking advantage of software flaws.

KYC Benefits to Cryptocurrency Traders 

Cryptocurrency trading appears to be appealing because it does not require you to reveal your identity in order to open an account and begin trading. It used to be that blockchain networks were completely anonymous, but that has changed as global regulations have become more stringent. 

In order to combat this phenomenon, many cryptocurrency exchanges have begun educating their customers about the benefits of KYC which includes;

Better Capability for Adaptation 

Customer benefits such as greater withdrawal limits, lower fees, and other trading privileges are available to those who provide personal information to the company. Even among cryptocurrency platforms, the practice of imposing a trade limit that is then lifted once the customer has completed a simple verification process is becoming more common. 

In the opinion of experts, the vast majority of clients are comfortable with trading companies having access to their most basic personal information. Aside from that, KYC verification can allow for the completion of large blocks of trades and large-scale transactions without the need for additional verification or delays. 

Protection of Assets

Trading firms frequently neglect the importance of Know Your Customer (KYC) processes in protecting customers’ funds. While an attack on a blockchain network is difficult, gaining access to it is not impossible. On the other hand, if KYC rules are implemented, customers will likely feel safer because crypto exchanges and financial institutions will be able to trace the trail of their funds and reimburse them as needed. 

Improved trading conditions 

In the near future, KYC in crypto will likely become the norm, as it will become increasingly difficult to operate a large-scale crypto trading business without becoming compliant with the regulations. Additionally, it’s risky because traders are at a competitive disadvantage when they open accounts with unregulated organizations that may not have sophisticated security procedures and asset protection plans in place.

Can you acquire crypto without KYC?

A decentralized exchange can be used to purchase cryptocurrency without the need for you to disclose any personal information such as your name, address, or date of birth to complete the transaction.

It appeared as though the crypto market was poised to do away with the time-consuming KYC verification process when Binance only required an e-mail address. For the vast majority of platforms, Know Your Customer (KYC) in the cryptocurrency market is now a requirement.

With any of the big centralized cryptocurrency exchanges, you’re asked to complete the Know Your Customer (KYC) process before being able to make any purchases or sell any cryptocurrency. But for privacy zealots, there are still cryptocurrency exchanges that do not ask users to disclose any sort of personal information in order to carry out crypto purchases such as dYdX Exchange, Uniswap V3, PancakeSwap amongst others.

Although KYC has been embraced by many, few users still take into consideration Decentralized Exchanges (DEXs) as a viable solution. Smart contracts, which are self-executing agreements encoded, and are used to facilitate these transactions since they are more efficient than traditional contracts.

It is as simple as creating a DEX account and linking it to their crypto wallet (which is typically a Web3 wallet like MetaMask) and you’re ready to go! In contrast to centralized exchanges such as Binance or Coinbase, DEXs do not have hot wallets. As an alternative, you can trade and exchange tokens using your own cryptocurrency wallet, guaranteeing that you retain complete control over your digital assets.

Conclusion 

KYC may soon be phased out in favor of a blockchain-based decentralized KYC system (DKYC). The Ethereum blockchain serves as the foundation for DKYCs solution architecture. It makes use of the Proof of Work consensus algorithm in order to validate a particular transaction, through the use of smart contracts. Each smart contract has its own unique address on the blockchain, which is used to identify it. The decentralized database also has all of the capabilities of a KYC system, including image data, which is stored in the cloud.

Ayo Alabi
Ayo Alabi is an experienced writer and Fintech enthusiast, passionate about educating people and helping businesses that want to see their Google search rankings surge. Her articles have appeared in a number of e-zine sites, with focus on balancing informative with SEO needs–but never at the expense of providing an entertaining read.

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