Cryptocurrency Regulation with KYC and AML Compliance

02.15.2022

As the digital economy becomes increasingly mainstream, many financial experts predict that digital currencies will naturally follow suit and become standardized. Cryptocurrency certainly holds a lot of potential in the world of contactless transactions, so much so that the demand in the crypto market is expected to continue its upward trend in the coming years. With more than 2000 types of cryptocurrencies currently available and more being developed, it’s no wonder that central bank authorities are hustling to establish cryptocurrency regulations.

Regulations concerning customer security, in particular, are hotly debated because Know Your Customer (KYC) requirements for Anti-Money Laundering (AML) compliance may cancel out the anonymous nature of transacting with crypto. KYC and AML compliance, however, does not have to mean discontinuity in the security of customers, even when anonymity is no longer possible. 

Cryptocurrency in a Gist

Cryptocurrency is a digital currency in the form of encrypted funds stored in a digital wallet and recorded in a public, online ledger whenever a transaction is made. According to Kaspersky, “Advanced coding is involved in storing and transmitting cryptocurrency data between wallets and to public ledgers. The encryption aims to provide security and safety.”

Using cryptocurrency makes it possible to make online transactions and funds transfers without a bank account. This means users don’t have to go through the usual identity verification that banks require from new clients as part of their KYC/AML compliance per government regulations. Therefore, the popularity of cryptocurrency within the digital economy may present serious fraud risks to companies that accept crypto payments and to crypto exchanges that facilitate these transactions. 

KYC and AML for Cryptocurrency Mainstreaming

KYC and AML processes are essential to the mainstreaming of crypto for fintechs. With many countries forbidding the trading of anonymous accounts, many cryptocurrency exchange platforms now involve obligatory customer identification.  

KYC and AML are standard processes for all financial institutions’ Customer Identification Programs (CIP). KYC and AML strengthen CIP and protect institutions from corruption, fraud, money laundering, and terrorist financing. Even within the digital environment, these processes help minimize risks despite digital technology's ever-changing and quickly evolving nature. 

AML compliance is governed by laws that prevent criminals from laundering or trying to legitimize illegally obtained funds. KYC verification involves best practices designed to verify the identities of new customers. 

According to Pymnts.com, $2.8 billion was laundered via crypto transactions last 2019, and this figure was $1 billion higher than the previous year. These illegal activities were made possible by exchange platforms having weak or zero KYC/AML processes. As a result, more and more exchanges are now implementing stricter KYC/AML compliance which, in turn, is also constantly being reformulated to keep up with digital innovations. 

In 2019, a joint statement was issued by the Financial Crimes Enforcement Network (FinCEN), the Commodity Futures Trading Commission (CFTC), and the Securities and Exchange Commission (SEC), defining cryptocurrency exchanges as money service businesses (MSBs) and subjecting them to AML and KYC regulations under the Bank Secrecy Act. New regulations for crypto wallets and crypto FOREX holdings soon followed. 

KYC, AML, and Information Security

Most crypto enthusiasts enjoy the anonymity afforded to them by digital currency, and KYC and AML regulations are still widely perceived as a threat to the security of their personal information. 

As more and more criminals are taking advantage of the anonymous nature of cryptocurrency, governing bodies are finding ways to also impose KYC compliance on crypto platforms (and not just on investment and financial services). While said compliance is not yet a requirement for crypto platforms, many have already started implementing their KYC processes to help curb criminal activity and avoid legal and reputational issues. 

KYC requirements for customers may vary for different businesses and jurisdictions, but a government-issued ID is the most common requirement for proof of identity. A secondary ID or other accompanying documents may also be needed to verify the person's address. While anonymity may no longer be possible, information security is often guaranteed by established companies. 

The Future of Cryptocurrency

Within the financial industry, including fintech services, anonymity is a luxury or a crime, or both. If mass adoption, and particularly institutional adoption of cryptocurrency, is to happen any time in the future, then cryptocurrency exchanges will have to abide by KYC and AML regulations. Widespread adoption of crypto will hinge on crypto exchanges guaranteeing safety, security and abiding by the rule of law to maintain the integrity of crypto markets in particular, and traditional financial markets.

Currently, crypto has been increasingly associated with money laundering, ransomware attacks, and other illegal activities. This association comes at the price of a bad reputation which, in turn, naturally leads to a significant reduction in the number of participants in crypto markets and massive fluctuations in crypto prices. 

Based on the current innovative solutions being devised within the crypto industry, which specifically address the issues of both identity verification and anonymity, there may be a way to reach a compromise so that KYC and AML compliance can be fulfilled while still allowing some degree of anonymity. Anonymous identity verification modules are a good example. This particular solution only requires a user to verify their identity once; they can then use this initial verification to prove their identity to new vendors, which means they don’t have to repeatedly provide their personal information. 

Cryptocurrency has already caused a huge paradigm shift in the way we make transactions; its stability in the future and the continuity of its success can only be ensured when crypto exchanges adopt effective KYC and AML measures.

Cryptocurrency Regulation

There’s still strong resistance against these regulatory measures being imposed on the cryptocurrency market. However, the need to address criminal activities involving cryptocurrency trumps the need for customer anonymity. The more cryptocurrency becomes mainstream, the greater the need to ensure the legitimacy of crypto transactions. 

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Instnt's fraud loss indemnification technology provides coverage of up to $100M for fraud losses stemming from synthetic, third-party, and first-party fraud. With Instnt's comprehensive fraud loss protection, businesses can confidently extend their services to a wider customer base, enabling them to embrace more opportunities and enhance revenue streams while maintaining a secure, fraud-free environment.