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TL;DR:
- KYC and the Travel Rule are equally critical to crypto compliance.
- KYC collects and transmits data on individuals and organizations that use an FI or VASP, whereas the Travel Rule requires FIs and VASPs to collect and transmit counterparty data.
- KYC programs typically have three components: a customer identification program, due diligence, and ongoing monitoring.
- Custodial wallet services associated with a VASP are required to have a KYC compliance program.
- VASPs need a cryptocurrency transaction monitoring system to report suspicious activity to regulators and help law enforcement track criminals.
Know your customer (KYC) is the first stage of anti-money laundering (AML) due diligence. When a financial institution (FI) onboards a new customer, KYC procedures are immediately followed to identify and verify the customer’s identity. These processes allow FIs to assess the customer’s risk profile based on their propensity for financial crime.
KYC is a process that cryptocurrency exchanges must use to:
VASPs undertake a multi-step KYC process to prevent fraudulent activity. The steps are as follows:
These steps help FIs determine each client's virtual currency money laundering and financial crime risk. If everything checks out, the customer is permitted to engage in certain activities on the cryptocurrency exchange.
A cryptocurrency transaction monitoring system aids crypto exchanges and FIs in identifying unusual or suspicious activity that they must report to regulatory authorities and assists law enforcement in tracking criminals. Transaction monitoring observes the risk associated with a cryptocurrency wallet. Virtual asset exchanges use tools provided by companies like Chainalysis, Elliptic, Crystal Blockchain, Coinfirm, etc.
Crypto wallets fall into two categories: custodial and non-custodial (self-hosted.) Only custodial wallets must comply with KYC practices, as they hold the private keys to a customer’s wallet. As mentioned on our VASP page, the Financial Action Task Force (FATF) defines VASPs as “any natural or legal person who exchanges, holds, safe-keeps, sells, converts, or otherwise transfers VAs on behalf of another natural or legal person.” VASPs are now regulated as financial institutions and must have a robust FYC framework. Self-hosted or non-custodial wallets such as MetaMask and Argent do not require KYC. Custodial wallet services associated with a VASP are required to have a KYC compliance program.
Despite operational adjustments and obstacles that arise when implementing KYC standards, cryptocurrency exchanges benefit significantly from regulatory compliance for the reasons listed below:
Verifying user identities benefits transparency and customer trust. When users feel confident that their cryptocurrency exchange is taking proactive and preventive measures to protect their accounts, they are more likely to continue using the service.
Between January 1, 2021, and March 31, 2022, more than 46,000 consumers reported losing over $1 billion in crypto to fraudsters. (Fletcher 2022) Vigorous identity verification can significantly reduce fraudulent activity and improve market reputation.
As legal requirements evolve, robust KYC processes will keep businesses ahead of the curve. KYC methods enable VASPs to prevent/limit fake identity instances, prevent money laundering, and assess customer risk by requiring government-issued identification and identifying financial history and assets. These steps allow businesses to reduce legal and regulatory risks, freeing time to focus on increasing conversion rates, expediting transactions, and ensuring compliance.
The cryptocurrency market is notoriously volatile because of suspicious, anonymous transactions. KYC programs that feature increased identity verification contribute to the market’s overall stability and value growth.
It is possible to purchase VAs without performing KYC. Crypto ATMs and decentralized exchanges (DEXs) don't require KYC, for example. Crypto ATMs let users buy cryptocurrency using cash or debit cards, whereas DEXs are blockchain-based P2P markets that permit large-scale crypto asset trading. DEXs do this using automated algorithms rather than acting as financial intermediaries.
Buying virtual currencies without performing KYC carries significant regulatory risk. Financial regulators such as The Office of Foreign Assets Control (OFAC) have punished cryptocurrency exchanges for apparent sanctions violations. A platform may detect black market accounts as fake, endangering assets.
Uniswap and Bisq are widely used DEXs without KYC processes. On these platforms, cryptocurrency sellers are matched with buyers based on order prices and volume, adding and subtracting from a "liquidity pool." A liquidity pool is a pot of crypto assets utilized to clear purchase and selling orders that appear. End users provide the assets rather than centralized liquidity providers.
KYC and the crypto Travel Rule are equally critical crypto compliance terminologies. KYC collects and transmits data on individuals and organizations that use an FI or VASP, Whereas the Travel Rule requires those FIs and VASPs to collect and transmit counterparty data. Learn how Notabene’s SafePII service leverages state-of-the-art cryptography to encrypt and store PII.
References:
Fletcher, Emma. 2022 | “Reports Show Scammers Cashing In on Crypto.” Consumer Protection: Data Spotlight.
Notabene is on a mission to make secure and trusted crypto transactions a part of the everyday economy. Using privacy-preserving technology, our end-to-end Travel Rule compliance software helps VASPs turn compliance into a competitive advantage.
Clients use our end-to-end Travel Rule compliance solution to identify virtual asset accounts, perform mandated VASP due diligence, and manage regulatory and counterparty risks from one holistic dashboard. Additionally, our powerful integrations from the marketplace allow clients to perform continuous transaction monitoring, an integral part of KYC measures.
Learn more about the messaging protocols that VASPs use to share customer information.
Future business opportunities after complying with the FinCEN Travel Rule are immense. FATF Travel Rule compliance presents the most significant opportunity for virtual assets to become widely accepted in everyday use cases. Cryptocurrency companies that comply will have better access to traditional banking, which will allow easier access to institutional investors. They will also be able to provide more visibility and trust around each transaction for their customers.
KYC is the process of identifying customers and verifying their details to comply with global regulations, including anti-money laundering and counter-terrorism financing laws. The overarching goal of the KYC process in crypto is to prevent individuals or companies from using the asset class to commit financial crimes.
KYC is the process of one VASP identifying their customer and verifying their details to comply with global regulations before allowing them to utilize their platform. Travel Rule takes it a step further–requiring two VASPs that have already KYC’ed their customers to exchange and store customer PII on transactions over a certain threshold.
Know Your Customer (KYC) is not only safe but critical to secure crypto transactions. Without KYC, it’s impossible to verify the parties of a transaction and avoid fraudulent scams due to anonymity. While Notabene does not directly provide KYC, our Wallet ID widget executes an integral part of the KYC picture.
Anti-Money Laundering (AML) and Know Your Customer (KYC) enforcement benefit VASPs and their end-users. Unlike fiat currency, virtual currency as an asset class does not have a solid regulatory framework. Some bad actors increasingly take advantage of transmitting and hiding the source and destination of their financial transactions. Standardizing regulatory practices and performing KYC and AML checks can help mitigate money laundering, terrorist financing, and illicit financing.
VASPs and Financial institutions looking to comply with the Travel Rule leverage our market-leading FATF Travel Rule solution to identify virtual asset accounts, perform mandated VASP due diligence, and manage regulatory and counterparty risks from one holistic dashboard.
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Notabene does not specifically touch KYC. However, Wallet Identification is one part of the KYC process. When an originator customer intends to send a transaction over the Travel Rule threshold, our wallet identification widget checks to see if the beneficiary is a VASP or a non-custodial wallet. Additionally, Notabene’s Counterparty Wallet ID Plugin allows originator VASPs to perform non-custodial wallet ownership verification.
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