Most investors enter into the crypto markets via cryptocurrency exchanges. Centralized crypto exchanges are regulated and they implement checks such as KYC to ensure consumer protection. This article talks about KYC and why crypto exchange implements it.
What is KYC?
KYC stands for Know Your Customer. It is a type of verification system that a digital application can use for user verification. KYC is added as a preventive measure on digital applications by government and application governance protocols as a way to prevent fraudulent activities.
KYC allows the digital application to ascertain the real identity of a new account holder by cross-checking it with government-issued identification or any other legally verified document.
Why do Crypto Exchanges Require KYC?
Cryptocurrency exchanges are often classified as financial services providers. Therefore, the financial regulators in a country impose the necessary checks on them to ensure consumer safety. Rather than traditional financial institutions, Bitcoin exchanges are often listed as VASPs or Virtual Asset Services Providers.
In accordance with the regulatory requirements of the local financial regulators and to obtain trading licenses, cryptocurrency trading platforms mandate KYC. Here are some examples for how a crypto exchange may use KYC:
Trading platforms implement KYC checks to confirm the legal identification and personal information of all account holders.
Crypto exchanges ensure that every consumer is operating their trading account with the government verified ID. At the same time, they can collect verified user data and conduct reliable surveys.
Crypto exchanges can ascertain the chances of money laundering risks associated with their clientele.
How does KYC Work for a Crypto Exchange?
Here are the following steps that crypto exchanges or VASPs implement KYC verification:
The platform mandates the consumers to provide personally identifiable information or PII. It can be in the form of government issued ID, driving license, passport, or any other legally verified document.
The exchange takes their time to compare the documents provided by the government officials with the government officials by linking or borrowing their data base.
The platform verifies the customer accounts and the consumers can now link their bank account or make deposits to start trading.
The platform monitors the customer particulars and trading activity and shares the required information with the government regulators to prevent illegal activities such as tax evasion and money laundering etc.
KYC and Travel Rule
Travel Rule is part of the Bank Secrecy Act (BSA) that ordains financial institutions to share necessary information with other financial enterprises. It is applied in the instances where funds are transferred through multiple FIs.
The purpose of KYC is to collect verified identification for individual and commercial traders present on any FI or VASP such as crypto exchanges.
However, under the Travel Rule these VASPs or FIs are required to collect and exchange counterparty data. In most cases, Travel Rule is imposed by financial regulators. Financial regulators implement Travel Rule to abide by the conditions of Financial Action Task Force (FATF). FATF is an international watchdog against money laundering and terror financing.
Advantages of KYC
Here are some important advantages of KYC:
KYC brings more transparency for all traders that are present on a crypto trading platform. It grants the consumers with confidence that all traders on the platform are legitimate investors with verified IDs and not threat actors trading under false pretense.
KYC check means that the regulators are able to detect and prevent money laundering practices on a cryptocurrency exchange. KYC protects the consumers against potential scams that can lead to massive losses for the investors.
KYC lessens the legal risks for the exchanges and allow them to work in association with the local financial regulators. In that they are cooperating with the authorities to prevent any type of illegal trading activities.
KYC checks on VASPs and FIs lead to safer trading environment for consumers and the market at large. Threat actors have a harder time to create accounts under fake name and participate in market manipulative techniques that can harm all the investors.
It is possible to trade cryptocurrencies without undergoing KYC checks. Some traders prefer to keep their financial history private and they can opt for secondary trading markets that do not require KYC for registration.
However, trading without KYC can expose the consumers to potential market risks such as dealing with frauds and increasing risks.