The development of financial instruments and the emergence of new financial platforms throughout history have been one of the strongest drivers for certain campaigns, organizations, and entire nations.
However, being just a vehicle, different parties can use it in different directions and make it an aid for realizing malicious ones. That’s why, along with the development of the financial sector, its regulations have evolved, particularly AML and KYC.
The same did not bypass decentralized finance and cryptocurrencies, which have developed so rapidly that they have managed to become a powerful vehicle for attackers of various scales in a variety of areas.
Today we’ll take a look at what KYC and AML are, where they came from, and how they evolved.
What are KYC and AML compliance in cryptocurrency? What are the KYC/AML challenges in crypto, and what is the importance of KYC for crypto trading for platforms and their users?
What Is AML?
AML or Anti-Money Laundering regulations are a set of rules and standards for financial institutions that are designed to prevent illegal money trafficking, financing of illegal organizations, and other financial activities that reinforce malicious activities.
The first global AML regulations appeared in 1989, thanks to the creation of the Financial Action Task Force (FATF) on the initiative of the G7 countries. Of course, at that time, it included regulation of financial institutions directly, but AML regulations evolved and especially intensified after 9/11, after which it was extended to related anonymous and unreliable counterparties and financing of terrorist and criminal organizations.
Thus, global AML regulations have spread more rapidly and are applied in all countries, although with their own differences with respect to local legislation. In general, the hierarchy is as follows:
1. FATF sets international AML standards for all member countries
2. The largest economies are the first to adopt this aligning with their legislative and technical framework
3. Smaller economies do the same, but with an additional look at their largest partners, such as the U.S. with its U.S. Treasury’s FinCEN Requirements or Europe with the EU’s 5th and 6th Anti-Money Laundering Directives
More specifically, the global AML policies for cryptocurrencies are the same as global AML policies for traditional finance from a principal perspective. FATF requirements include 4 key ones:
- Customer Due Diligence (CDD). This requires financial institutions and platforms to verify the identity of their users so that in the event of illegal activity, the offense can be proven in the case of a specific individual.
- Transaction Monitoring. This requires that they monitor transactions for suspicious factors, such as extremely large amounts, recurring payments, payments to under-the-table addresses.
- Reporting Obligations. This requires that if suspicious transactions are detected, financial institutions and platforms contact regulators to identify likely malicious activity behind these payments.
- Record Keeping. In reverse order, financial institutions and platforms must keep a history of transactions in case regulatory or law enforcement agencies need information about financial activity while investigating a case.
What Is KYC?
KYC, or Know Your Customer, is an implementation of the CDD standard that provides a detailed framework for verifying a user’s identity. In particular, KYC specifies which identity documents are considered valid for this purpose, the order in which they should be requested and stored, and so on, depending on the jurisdiction.
What Is KYC in Crypto?
As technology evolved and implemented financial systems – AML and KYC adapted too. But suddenly, technologies emerged that enabled decentralized finance, or DeFi.
The first such decentralized financial network was Bitcoin, and later came Ethereum, which allowed the creation of entire decentralized applications (DApps) and decentralized organizations (DAOs). AML regulators were not prepared for this sudden emergence and rapid development of systems already in operation, so for a while, they remained uncovered and gained some of their dark reputations.
However, now the existence, development, and adaptation of blockchain technology and all of its applications is probably undeniable to most, and AML regulators have already adopted their standards for the crypto industry and blockchain platforms, aiming to prevent their abuse by malicious actors.
AML Guidelines for Blockchain Platforms
Now, crypto regulations and AML laws are mandatory for all cryptocurrency services and providers to prevent their use in money trafficking, money laundering, and financing of criminal and terrorist organizations.
Depending on which jurisdiction the provider is registered in, the requirements imposed on them may vary, but they all correspond in one way or another to the four FATF standards with which you are already familiar.
At a basic level, this comes down to essential rules such as daily deposit and withdrawal limits, restrictions on certain trading instruments, and other things that are required by local law.
More specific to the 4 key principles, the KYC process for crypto exchanges in one jurisdiction may allow the use of a driver’s license as identification, while in another jurisdiction required to accept only a passport.
AI helps not only trade crypto but also protect trades and trading platforms. They implement it to proactively analyze suspicious transactions, and identify patterns and anomalies to proactively resolve threats. If detected, they can take immediate action and freeze the account if the situation is ambiguous. However, if the support team is not convinced otherwise and has indisputable evidence, they may be required to make a report to regulators.
And of course, crypto platforms are required to keep transaction history. This may seem unnecessary, as all transactions on the blockchain are already open and immutable. But here we are also talking about fiat funds that the user enters and withdraws from the platform, as well as uses for its services.
Learn more about the KYC requirements and processes on top crypto platforms like Bybit, BloFin, MEXC, WEEX, and more in our in-depth reviews.
KYC/AML Challenges in Crypto
Those familiar with how blockchain-based solutions work can immediately see the contradictions, ranging from ideological to technical.
From a technical point of view, the application of AML can be largely hampered by the decentralization of blockchain networks, where there is no single owner or person in charge. Even the creators of a blockchain network such as Ethereum cannot make single decisions that determine all aspects of the Ethereum network.
Another problem is the resistance of the crypto community, which finds a contradiction between the requirements of AML and KYC and the basic principles of Web3, such as decentralization, anonymity, and data ownership.
A third problem is the availability of technical solutions that can be used to circumvent AML and KYC restrictions and requirements, such as P2P exchanges, anonymous blockchains like Monero, and crypto-mixers that often help attackers make it harder to track crypto transactions.
Of course, if you remain averse to KYC solely for ideological reasons, and your trading does not involve large volumes – then there is good news for you. Most cryptocurrency platforms allow you to legally trade without KYC as long as transaction amounts do not exceed the limits set by regulators. Learn the Best Platforms to Buy Bitcoin without KYC, where we compare their features, pros, and cons in detail.
Benefits of KYC in the Crypto Industry
That said, KYC in the crypto industry serves as a critical element that provides safety and sustainability for users who find crypto a more preferred financial instrument in a number of cases.
✅ KYC for Legal Safety of Crypto Platforms
In order to legally provide their services to users, platforms are required to implement AML/KYC compliance, preventing money laundering in crypto. This simultaneously protects both crypto platforms and their users from falling outside the legal framework.
✅ KYC To Build Social and Financial Capital
The second follows directly from the first, as KYC creates trust in the platform among crypto traders and enthusiasts. Moreover, it is even more important for platforms in the context of institutional investors, as their choice of platforms provides crypto platforms with a resource for Research & Development and Marketing departments.
✅ KYC to Create Accountability
KYC also helps crypto platforms weed out malicious actors because, in the context of conducting large transactions to suspicious addresses while maintaining anonymity – it becomes inherently unsuitable for technical considerations.
Conclusion
The history of AML and KYC regulations in the crypto industry has not evolved in line with the speed of technology development. Moreover, it is not over, as blockchain technologies continue to develop and adapt, so they require constant regulation improvements.Â
However, they are already mandatory for all platforms to legally and sustainably trade cryptocurrencies worldwide. To keep up to date with the latest updates on global crypto and blockchain regulations, and get actual information that helps make your trading more efficient and secure.
Disclaimer: The information provided in this article is for informational and educational purposes only and does not constitute financial, investment, or trading advice. Any actions you take based on the information provided are solely at your own risk. We are not responsible for any financial losses, damages, or consequences resulting from your use of this content. Always conduct your own research and consult a qualified financial advisor before making any investment decisions. Read more
