Know Your Customer (KYC) procedures play a fundamental role in the combat against money laundering and the financing of terrorism (CFT). According to a 2018 report by KPMG, banks spend close to $25 billion every year on financial crime risk management. Nonetheless, it is all for a noble cause, given the rise of financial crime and terrorist financing in recent years.
While KYC procedures for different governments and private institutions seek to solve similar issues, the approach varies from one jurisdiction to another. For instance, in some advanced countries like the U.S, the citizens are often subjected to more stringent KYC processes than their counterparts in developing economies.
Likewise, the KYC approach for different financial markets varies depending on fundamental factors such as the type of investment or the regulatory frameworks governing a specific market. Today, we have emerging niches such as the crypto market, where KYC procedures are less rigorous than the traditional markets standard.
Should that be the case? Well, there are many takes on whether KYC should be incorporated within crypto ecosystems. On the one hand, regulators are pushing for the adoption of similar KYC measures that govern existing financial markets. Meanwhile, some crypto stakeholders are hell-bent on preserving the value of anonymity, noting that KYC takes away this aspect.
The KYC Debate in Crypto
For a long time, the crypto market had operated with minimal regulations until recent years when regulators caught up with the trend. This need for a compliance oversight has given rise to several regulatory frameworks such as the European’s Union (EU) 5th Anti-Money Laundering Directive (5AMLD), which came into action in January 2020.
At first, crypto-related businesses were hesitant on adopting the 5AMLD but most folded over time; the rest have since opted for more regulatory-friendly jurisdictions such as the Cayman Islands, Cyprus and Bermuda. The question, however, are these jurisdictions crypto-friendly or simply complacent when it comes to compliance oversight?
While there are many takes depending on which side of the fence one sits on, a recent report by the Ransomware Task Force suggests that KYC/AML procedures could play a significant role in toning down the number of malicious attacks. Most ransoms today are paid through cryptocurrencies like Bitcoin, enabling the attackers to hide their tracks.
Per the report, the adoption of a coordinated international crypto KYC approach could solve the growing ransomware problem as attackers will be easily tracked based on their personal information,
“The cryptocurrency sector that enables ransomware crime should be more closely regulated. Governments should require cryptocurrency exchanges, crypto kiosks, and over-the-counter (OTC) trading ‘desks’ to comply with existing laws, including Know Your Customer (KYC), Anti-Money Laundering (AML), and Combatting Financing of Terrorism (CFT) laws,” read the report.
Going by these sentiments, it is evident that crypto ecosystems need to adopt some level of KYC or at least match the current financial market standards. Unfortunately, that may not be as simple as it sounds; nascent crypto niches such as Decentralized Finance (DeFi) have proven the ability to maintain anonymity given their underlying infrastructure.
So, how can a standard KYC procedure be introduced for all crypto ecosystems? The answer lies in the potential of blockchain technology.
Blockchain’s Role in Implementing KYC
The crypto ecosystem is built on blockchain technology, leveraging its value as a decentralized infrastructure. Over the years, a lot of focus has been on maximizing this value to introduce a self-sovereign ecosystem where anyone can participate. However, stakeholders are now realizing that blockchain can do much more than support cryptocurrencies – the technology can also be used to develop cost-friendly and verifiable KYC frameworks.
KPMG, in collaboration with Bluzelle Networks, a consortium of three banks in Singapore (Mitsubishi UFJ Financial Group, OCBC and HSBC), carried out a Proof-of-Concept (PoC), testing blockchain’s capabilities in developing an integrated KYC ecosystem. The test, which passed Singapore’s Monetary Authority test scenarios, revealed that a shared blockchain-based KYC framework could reduce the cost of KYC procedures by 25-50%.
“The platform could result in estimated cost savings of 25–50 percent by reducing duplication and providing a clear audit trail.” highlighted the report.
Can this be replicated in DeFi ecosystems? Though not exactly, DeFi projects like Safle have advanced the concept of decentralized digital identities. This non-custodial wallet provider uses blockchain technology to give crypto users a unique digital identity. As such, users can use the digital identities stored in Safle’s vault for KYC verification on various platforms.
Notably, Safle’s ID feature supports EVM compatible smart contracts, allowing users to operate on other networks such as Polygon, Ethereum and Binance Smart Chain (BSC) through their decentralized identities. At the core, Safle’s blockchain tech stack is a KYC enabler with more flexibility, given that users can choose not to share their personal details.
With the DeFi ecosystem growing by the day, there is a need for decentralized KYC solutions such as Safle’s. More importantly, these innovations have to uphold the fundamentals of DeFi: security and autonomy.
While it may stifle innovation and adoption to some extent, implementing KYC procedures will propel the industry forward in the long term. It is not surprising that leading exchanges like Binance are now working closely with regulators to adopt the best KYC practices. The exchange recently expanded its KYC policy, requiring all users to complete intermediate verification before accessing the platform’s services and products.
As for the latest KYC crypto laws, the U.S infrastructure bill requires crypto users to collect KYC information for transactions above $10,000. The bill recently passed by the U.S Senate cuts across all crypto niches, including DeFi. Going by these developments, it is crystal clear that crypto KYC is no longer an issue of debate but a question of implementation. Therefore, Crypto users have little to no option but to adopt KYC solutions such as decentralized digital identities.
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