How regulated do you think cryptocurrency should be? For some, crypto is a symbol of independence from governments and a motto of libertarian freedom. For others, it’s an incarnation of anarchy that supports illicit activity and should be immediately taken under control.
Back in the early 2010s, no one would take crypto seriously, and there was a lot of freedom in the emerging market. Over time, some started to abuse this freedom and became involved in criminal actions. They stole money from hacked wallets and scam projects and then sent it to the “white” addresses to make it look legal. This is called money laundering, and it is still present in the crypto market.
To fight crypto launderers, exchange services started to implement an Anti-Money-Laundering policy (AML), an important part of which is the Know-Your-Customer verification procedure (KYC). Let’s see what they are and how they work.
What is AML?
AML is a legal framework designed to fight stealing money and its illegal storing. It includes a number of laws that work in multiple countries, and all crypto services based in these countries have to comply with them.
Now, let’s take a closer look at how money is typically laundered.
Money Laundering Stages
- Placement. After launderers steal money, they need to put it somewhere to make the whole thing look legal. For instance, they can put it into an account at a crypto exchange without KYC (with no identity verification). Remember: these non-KYC crypto exchanges allow for a great experience to buy crypto without KYC, but they are often a target for money launderers.
- Hiding. Since everything is traced on the blockchain, you can’t simply send crypto directly from one place to another to make it look legal. Money launderers use sophisticated methods to deceive the system and confound the path of the stolen funds.
- Integration/Extraction. Criminals hire fake workers, manipulate loan dividends, or send crypto to offshore banks to disguise the source of money. The aim of this is to make money look like profits drawn from a working business.
What Makes It Harder to Catch Money Launderers?
- Payments in the dark web. If you pay with stolen money for a hotel or a train ticket, you may be caught. But if you pay for child pornography or guns in the darknet, there’s simply no one there to check you.
- Market manipulation. Scammers build fraudulent cryptocurrency exchanges and malicious smart contracts to attract users and then steal their money. Lack of regulation is why fighting money laundering here is challenging.
- Poor security in crypto wallets and custodial platforms. Code vulnerabilities make it easier for money launderers to break in and send the funds where they need.
What is KYC?
Now, let’s explore the Know-Your-Customer procedure. This is a tool used by banks and other traditional financial institutions as well as crypto services to verify the identities of the customers.
KYC is a key part of AML. It is mandatory for most of the crypto exchanges: it helps them understand that their customer is a law-abiding citizen and doesn’t have any bad intent. At ChangeNOW, KYC is required in two cases: if an exchange sum is very large and if a transaction is marked as suspicious by our risk management system.
If asked for KYC, you need to submit your photo and your official ID document such as your passport or driver’s license. Sometimes it’s also a selfie with a special printout and/or some financial documents.
KYC Cases, and What Comes After the ID Check
For crypto-to-crypto and fiat-to-crypto exchanges, KYC policies may be a little different.
- Crypto-to-crypto. If you are only going to use your crypto exchange account for no-fiat trades, you might be subject to the limited version of KYC. It depends mainly on where you live: AML crypto laws vary from country to country. As we mentioned before, no-KYC crypto exchanges are often involved in money laundering, so the USA and European countries are planning to introduce cryptocurrency KYC for most of the crypto-to-crypto exchanges.
- Fiat-to-crypto and vice versa. While crypto still can be anonymous, digital fiat money barely can. Fiat providers for crypto services, as well as banks, want to know your identity. That’s why buy & sell crypto operations require a crypto KYC check almost always. In case of ChangeNOW, 99% of crypto-to-crypto swaps are anonymous, but KYC is typically required for the fiat-to-crypto ones. The same is relevant for some of the crypto exchanges.
KYC/AML is not over after you’ve gone through ID verification. There are some other operations that are less visible to the eye of the customer:
- Risk Level Assessment. In compliance with the KYC policy, exchanges check if you are from a banned or sanctioned country, if you are affiliated with terrorists, and if you have contacts with politically exposed persons (these are under close attention due to the risk of bribery and corruption). Both new and existing users are assessed.
- Transaction Monitoring. Cryptocurrency services watch your activity for signs of behavior that they find suspicious. This is mainly drawn from your totally anonymized transaction data. ChangeNOW doesn’t disclose criteria for marking transactions as suspicious ones: if it did so, it would become much easier for the fraudsters and money launderers to abuse these criteria.
- Enhanced Due Diligence. As it follows from the point above, crypto platforms constantly monitor their users’ activity. In EDD, every transaction and user are designated a certain risk level: low, medium, or high. If the risk is low, a transaction passes on easily, while medium- and high-risk operations and users can be subjected to more precise monitoring. A sudden change in a user’s behavior pattern is often a signal to raise the risk level. Some of the high-risk transactions may ultimately be money laundering attempts.
Why is KYC/AML Important for Mass Crypto Adoption?
In late 2020, we witnessed a meteoric rise of Bitcoin and the Bitcoin-dependent crypto market in general. It has drawn a lot of attention to cryptocurrency: today, more and more people think about investing in digital assets. In the USA, many were reporting they are to invest their fresh $1,400 stimulus checks in cryptocurrency. Okay, how can AML and KYC help this process?
For regular users, feeling safe in crypto is a must. Projects that ensure strong KYC/AML compliance allow more people to enter the crypto market because they provide a feeling of being protected from fraud.
For investors who are looking for startups to fund, a project’s adherence to AML also gives them a signal of reliability and safety as such projects are more protected from fraud.
For many people, cryptocurrency is a land of opportunity, but for some, this opportunity is of ill intentions. Money laundering — stealing money and then sending it elsewhere to make it look legal — is becoming harder every year, but some still practice it. To fight it, AML and KYC procedures are implemented: usually, it is an ID check as well as some transaction monitoring that helps to identify malicious activity.
Yeah, KYC check might be a little annoying. It requires taking a selfie and sending a photo of your document (and even more in some cases). But next time you do it, you will know how important it is to fight crime in the crypto space — so everyone including you can stay fine and safe.