Know Your Customer (KYC) is a regulatory requirement that by delivering trust between customer and financial institution, underpins the global economy. Without KYC, a bank’s assets — including those of its good customers — remain vulnerable and at risk.
Unfortunately, the current processes surrounding the execution of KYC are inefficient and outdated. Across the globe, financial institutions find themselves conducting time-consuming, cost-heavy checks in order to verify their customers’ identities. Not only do they face massive fines if they fail to comply with existing regulations but they often have to navigate between many different regulatory borders, as well as storing and protecting huge swathes of user data.
The Cost of KYC
In 2020 alone, global financial institutions were fined $10.4 billion related to anti-money laundering (AML), KYC and data privacy issues, according to Payments Journal. This seems quite high, but perhaps inevitable, when considering the increasingly complex and never-ending requirements forced by regulators upon financial institutions.
Unfortunately, KYC checks are not one and done. They are not only performed at the beginning of a business relationship, such as when a customer is onboarding and attempting to open an account by providing the necessary documents and identity verification. Instead, institutions are required to conduct KYC checks and monitor customer transactions on an ongoing basis, which takes up a significant amount of time and resources.
Apart from time and effort, complying with KYC rules also costs banks money. According to research firm CB Insights, banks spend up to $500 million annually on KYC compliance and customer due diligence.
Technology, of course, is usually the solution, as a way to bring efficiency, speed and lower costs. More specifically, blockchain technologies — especially those that serve as the foundations of decentralized finance (DeFi) — are rapidly being introduced to provide solutions for the KYC and identity verification issues that financial institutions face.
“Blockchain can help to reshape outdated KYC processes by allowing for the effective outsourcing and decentralizing of personal data, while also allowing the owner of the data to maintain full control over their data,” explains Nasdaq.
In a portable KYC blockchain solution, the individual customer controls their own identity, using self-sovereign identity standards from W3C. Consumers can use it to authenticate, validate and onboard to any app — not simply a financial institution — that requires that the consumer present credentials. In this manner, there is more control by the consumer and trust by the financial institution.
How KYC on the Blockchain Works
There are four steps to deploying and using the blockchain for KYC. Let’s have a look.
Step 1: A financial institution deploys a blockchain-based KYC platform
This is, of course, an obvious first step. This platform would just be for the KYC process, and no other bank functions. IT and risk management teams should devise a solution, and consider the options for the storage of customer data:
- A centralized, encrypted server
- The financial institution’s private server
- A distributed ledger technology (DLT) platform
Step 2: The user builds a profile on the KYC DLT system
As part of a one-time setup, the customer must complete a profile using their government-issued identity documents. Once uploaded, the data becomes accessible to the financial institution for verification purposes.
Step 3: The user begins to engage and enter into transactions with the financial institution
When the user performs a transaction with the financial institution, they give the institution the right to access the user’s profile. The financial institution then verifies the KYC data via the blockchain platform they’ve selected and saves a copy of the data on their server.
Next, the institution uploads a hash function on the DLT platform. A hash function is a cryptographic algorithm that takes a group of characters (called a key) and maps it to a value of a certain length (called a hash value or hash).
Finally, the institution transfers KYC digital copies to the user’s profile embedded with a hash function that matches the hash function uploaded on the DLT platform.
This is a security feature because if the KYC data is altered, the hash function of the KYC data won’t match the one posted on the DLT platform. This alerts the other financial institutions on the blockchain of this discrepancy or change.
Step 4: The user performs a transaction with a second financial institution
When a second financial institution requests that the user perform KYC, the user would grant the second institution access to their profile.
The first financial institution would receive an alert and then review the KYC data and its hash function with the hash function uploaded by the first institution. If the two match, the second financial institution would know that the KYC is the same as the one received by the first institution.
In the event that the hash functions don’t match, the second financial institution would have to manually validate the customer’s KYC documents. These discrepancies are not always concerning fraudulent or stolen documents. Consumers regularly obtain new government-issued ID cards, such as when they change addresses or get married, or when their documents expire. To accommodate these changes, financial institutions can leverage blockchain smart contracts to automatically update their systems when the user provides new documents. In this instance of updated documents, the user submits the new document first to the financial institution, which then broadcasts the change across the blockchain using the new hash function, which then becomes accessible to other financial institutions.
Benefits of Blockchain KYC
There are several benefits of having KYC on the blockchain — for both customers and institutions including:
1. Secure Data Collection
The decentralized network of blockchain in KYC produces results in data being accessed securely by both parties after permission has been given to them. Essentially, instances of unauthorized access are eliminated because the security offered by the blockchain means that data can only be accessed after permission has been given by the customer. This benefits both the customer and the institution.
2. Improved Efficiency
The decentralized blockchain works faster and reduces the time to onboard customers. Legacy KYC processes often require the use of several disparate systems and databases that must each run their own checks in sequence, thereby slowing down the process. As such, KYC can easily expedite customer onboarding time and with no third-party, licensed databases, resulting in lowered regulatory and compliance expenses.
Blockchain tech can help reduce the human effort and cost involved in KYC compliance. Using blockchain for KYC purposes could reduce personnel requirements for banks by 10%, equating to cost savings of up to $160 million annually.
3. More Accurate and Valid Data
One’s identity on the blockchain is immutable. Because transactions are transparent, carrying out KYC on the blockchain enables financial institutions to validate the accuracy of the customer’s identification data in the distributed ledger. Because one owns their own identity and data, and are the only ones with the ability to change it, financial institutions can know that during onboarding, they are accessing the most trustworthy, up-to-date user data.
4. Real-time Updated User Data
In the old way of onboarding, a customer knows when they are onboarded, but the individual documents do not keep their own records of when they were presented and used to verify the owner’s identity. With a KYC blockchain solution, every time a KYC transaction is performed at a financial institution, that information is shared within the distributed ledger.
Beyond security, efficiency and accuracy, this is perhaps the most important benefit of using blockchain for KYC, as the solution enables other participating institutions to access real-time updated information with a guarantee that every time there’s a new addition in the documents or there are any modifications, they’ll be notified. Without KYC on the blockchain, financial institutions will have no way of knowing whether their new customer had also recently onboarded or opened accounts at other institutions.
Onboard More Valuable Customers With Instnt Access™
Instnt Access™ is the industry leader in decentralized customer onboarding and portable KYC technology that provides a fully managed hyperledger blockchain for decentralized identifiers (DIDs). Insnt’s fully managed and frictionless solution saves financial institutions time, money and other resources so that they can focus on their core operations: signing up customers and boosting revenue. For more information on Instnt Access™, start your free demo today.