What is KYC and its association with Crypto

 

What is KYC and why what is its importance?

Do you remember Bhutan Telecom Limited or any banking institutions in Bhutan mandating the need of KYC or e-KYC in the recent years? What is KYC?

KYC refers to financial institution’s obligation to carry out certain identity and background checks on its clients before allowing them to use its products or platform.

Know You Customer (or Know You Client) is a standard or a process used by investment firms to assess investors they are conducting business with. KYC has been now a legal and regulatory requirement made worldwide, aimed at propagating good business practice for the company as well as to understand investment opportunities and to reduce risk from suspicious activities and could prevent the liability such as the association with money laundering and frauds. In a nutshell, it the process of identifying who your investors/customers/clients are (their identity); understand the nature of customer’s activities and qualify that the source of funds is legitimate; and assess money laundering risks associated with the customers. Getting the detailed information about your customer protects both parties in the business transaction and relationship.

KYC is a standard requirement worldwide within the investment industry and, aims at protecting all stakeholders within the industry from any suspicious activities as there is a lot of money at stake. Some companies (such as investing companies or mobile/internet service providers) use KYC to assess their customers, thus looking at improving servicing and management of investors over the course of the relationship. This would also establish trust in a business relationship and give an organization insight into the nature of customer activities.

What is AML?

The KYC process is a key part of the overall AML (anti-money laundering) framework and specifically requires organizations to know who they do business with and verify customer identity. Now, what is AML? AML refers to the framework of legislation and regulation financial institutions must follow to prevent money laundering. However, AML legislation can vary by jurisdiction or country, meaning financial institutions or investing companies must establish KYC procedures that comply with the AML standards.

For the companies, KYC and its policies will reduce the financial risks of their business arrangements with particular customers. Knowing the source of a customer’s income, gauging their capability of investing in your market, and obtaining their complete financial portfolio and background are important aspects of KYC requirements. Those checks can also be vital risk management strategies to avoid getting entangled in business relationships with potential customers who have participated in  illegal activities.

For the customers/clients, the importance of the KYC may not be evident from the investors’ point of view, however they create a secure and trustworthy environment to enable financial or investments activities with the company. In addition, unlike the traditional method of onboarding customer information into the system that takes months has transformed into an intuitive experience with the availability of digital technology. With the digital technology behind protecting sensitive information, having an authenticated access to the services of any organization, would give the confidence to the customers.

Seamless KYC workflows will make your customers feel they are working with a legitimate company and more comfortable allocating funds to your firm or not. 

What is the KYC process?

While the exact steps may differ based on KYC laws across different countries, most of the frameworks include the same elements. A KYC process usually consists of verifying the customer’s identity, investment suitability, and due diligence on various documentation such as proof of address and income.

KYC and Cryptocurrency

As the cryptocurrency industry grows and matures, global and national financial regulators are putting more importance on firms to comply with the same rules (as traditional banks) while operating digital asset services. But as we all know that cryptocurrency or the blockchain is a decentralized network without any need of central authority-allowing customers to remain anonymous and keep their personal information private from any central authority, KYC is just the opposite i.e., the ‘KYC’ database centralized and managed by the central authority such as the investing company.

However, on the other hand, crypto does need KYC to tackle malicious activity in the crypto space, such as ransomware attacks that block a user’s access to a computer/network until the payment is made. For example, in 2020, victims paid nearly $350 million to crypto to attackers, who leveraged the anonymity provided by decentralized cryptocurrencies to evade detection. Thus, international experts have proposed on enabling stronger enforcement of KYC laws in the crypto section. VASPs (or Virtual Asset Service Providers such as Custodianship, Wallet providers, mining pools, brokerage services, bitcoin ATMs) are required to have a KYC compliance program.