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What is AML/KYC?

AML and KYC for Crypto

How does this influence the crypto industry?

Cryptocurrency is popular for its decentralized, owner-free, secure, and anonymous nature. However, all of these factors make it ideal for criminal thefts and illegal activities. It is even possible to fund terrorism, avoid taxes, and perform money laundering by using cryptocurrency. The structural design of cryptocurrency makes it arduous to track the identity of funding entities.

Technological advancements have made it possible to acquire financial products in a fast and effective way through digital currency with diverse levels of anonymity. On the other hand, this innovation also raises some challenges and concerns to the anti-money laundering system at the global level.

This isn't an exciting area but it is important; for our own safety and for the future of crypto.

AML/KYC and Cryptocurrency Regulations

Strict security measures need to be introduced in all crypto exchanges, with the increasing demand for this currency. Before you indulge in learning about the latest updates on AML/KYC regulations, let's have a look at these terms and their purpose.

  • Know Your Customer (KYC)

KYC is a customer identification process where a series of steps and cycles are applied to identify the users/customers. In KYC, items such as name, ID, photo, residential address, passport, driving license, contact numbers, etc., are required from users as proof. The main purpose of know your customer panels in crypto exchanges is to ensure that unqualified customers do not enter the trading system such as people with criminal records and fake/undocumented identities. This panel acts as a database of proof if a user performs any illegal activity in the future.

  • Anti-Money Laundering (AML)

The laws, regulations, and set of procedures of AML monitor criminal activities, like tax evasion, illegal use of funds and market manipulation.

AML regulations have made it compulsory for every financial institution to prevent fraudulent activities by conducting due diligence procedures.

  • Cryptocurrency Regulations

Other than AML/KYC, many countries have imposed cryptocurrency regulations to monitor closely anonymous and untraceable transactions. Since a huge amount of funds is poured into the market pool, the governments and financial organizations have made these laws to interpret every move made through cryptocurrency.

The Cycle of Money Laundering performed through cryptocurrency

People use several ways to perform illicit activities of money laundering, such as drug dealing payments, cross-border transactions, inheriting the pseudonymity of crypto coins, etc. The money laundering performed using cryptocurrency involves three basic steps:

Money Laundering and Crypto
  1. Placement

In this step, intermediaries such as exchanges, financial institutions, and casinos are used to inherent funds in the system. Crypto funds are bought through money or other native cryptocurrencies. Criminals then use those exchanges that have no or little compliance with AML/KYC regulations.

  1. Layering

In this phase, the criminals conceal and encode illegal funds through structure transactions, thereby making it arduous to decode their trail. Criminals can then trade and transform their currency to another cryptocurrency, and can transmit their holdings outside the country.

  1. Integration

In this step, OTC brokersensure that the illegal money is clean. Many expert brokers receive commissions for putting money back into the economy in a clean way.

Why is AML/KYC necessary for the Crypto Future?

AML and KYC regulations assist financial institutions around the globe to prevent fraudulent activities from taking place by account holders. For the future of crypto, it is important in the following ways:

Digital Identity and Crypto

Non-violation of International Regulations by Exchanges: Many countries have declared cryptocurrency illegal because the exchanges do not abide by AML/KYC regulations. For crypto to become legalized, it must follow certain laws, so that basic customer information is accessible to ensure legitimate transactions.

Increase in Mass Adoption: The absence of AML/KYC rules hinders mass adoption and institutional adoption. Large corporations will only accept cryptocurrency if AML/KYC verification mechanisms are introduced in exchanges.

Reduce Scams: The crypto system is a pool of frauds due to its unregulated nature. Assets worth millions of dollars can be stolen from exchanges without leaving a mark. With the introduction of an innovative AML/KYC system, it would be easier to find scammers among users and the government can trace crimes.

So, “anti-money laundering” and “know your customer” regulations play a vital role in ensuring mainstream adoption of cryptocurrencies worldwide.

Four Phases of the AML/KYC Process

For global acceptance and appreciation, cryptocurrency exchanges must adhere to these four general ways of AML/KYC:

Phase 1:

Policy for Customer Acceptance

According to this policy, only those customers are accepted whose profile is maintained by conducting due diligence to create an appropriate identity for the user. The exchange must ensure that a customer meets the criteria mentioned in the customer acceptance policy.

Phase 2:

Customer Identification Program

Under this phase, the financial institutions validate the identity of a customer who wishes to perform any transaction.

Phase 3:

Monitoring of Transactions

Processes like monitoring of transactions and reporting suspicious/doubtful activities come under this phase of AML/KYC.

Phase 4:

Ongoing Risk Management

Ongoing risk management is required in case any activity is suspicious. Exchanges must implement an AML/KYC system that contains a dashboard for continuous data evaluation and that shows key risk indicators.

AML/KYC Compliance in Crypto Industry (2021)

The Financial Actions Task Force (FATF) introduced travel rules for virtual asset service providers (VASPs) in 2019 worldwide. The EU has also introduced a fifth money laundering directive and the sixth money-laundering directive for the crypto industry, with more strict rules, which will be implemented by the end of 2021.

EU 6AMLD: The EU has made sure that all crypto exchanges should follow a challenging sixth directive from next year. The 6th AMLD has made it mandatory for all crypto firms to follow AML and KYC checks and regulations, and as well as perform CDD (customer due diligence). EDD (Enhanced due diligence) is a requisite for customers who travel from third-world countries. A list of 22 offenses about tax crimes, laundering, and cyber-crimes, is contained in the 6 Anti-money Laundering directive. There will be fines in cases of non-compliance. Imprisonment of one to four years is the minimum penalty for financial crimes and money laundering.

UK & all other countries: In the UK, all crypto firms do comply with new directives of the AML regulations. The UK has introduced its version of directives and as a process of the Know Your Customer phase the client is obliged to provide the following credentials:

  • Full Name

  • ID

  • Date of birth

  • Residential proof

This data must be accurate so that the AML compliance program performed later on will not be in vain.

Recommendations of FATF for Crypto Industry

For smooth and secure operations in the crypto sector, the Financial Actions Task Force has set some specific rules and regulations. These laws applied to crypto exchanges to create a scam-free environment for crypto trades. If it is unable to comply with the rules, the crypto will be heavily fined. The FATF states that:

  • A proper procedure of customer due diligence must be developed by all virtual asset service providers. CDD helps in evaluating the risk a customer is going to bring into the system by conducting a potential background check.

  • CDD needs to be conducted occasionally to keep a check on people who trade with amounts more than USD 1000 and EUR 1000.

  • Enhanced due diligence (a KYC process) is significant for potential risk assessment in dealing with new people who have a high net worth. Expert compliance officers should conduct the client screening.

  • It is necessary to perform AML screening for business dealings in the B2B market.

  • Customer names and their wallet addresses should be kept in record.

KYC Types and Processes in Crypto Exchanges

KYC is applied to crypto exchanges after a user signs up. According to a recent report by a famous blockchain analytics company, two out of three top exchanges possess weak verification systems. As a result, many crypto exchanges are in a non-compliant state with FATF rules.

No KYC at all: These kinds of exchanges do not use any KYC when a user opens an account. However, they provide very little functionality to their users; for example, no withdrawal is allowed.

Basic KYC: Exchanges operating under this type require an ID upload from the user and set a withdrawal limit.

Full KYC: A full fundamental KYC should be conducted for users who want to trade with large sums of money.

AML/KYC in Flat-to-Crypto Exchanges

In these exchanges, users trade with a native currency like Dollars, Euros, Rupees, etc., and transform it into cryptocurrency. Coinbase, Gemini, Kraken, Bitfinex are some popular exchanges. In coin base, there is no KYC; but transactions are continuously monitored in case of AML.

Gemini starts conducting KYC as soon the user opens an account and AML surveillance is conducted by the NASDAQ market team.

AML/KYC in Crypto-to-Crypto Exchanges

Exchanges like Binance and OKEx permit users to exchange crypto for another cryptocurrency. In Binance, there is no KYC for trading with BTC; however, AML is continuously monitored by the system. There is no known source of AML for OKEx, and KYC is only applied for withdrawals and advanced features.

Wrap Up

We can expect that cryptocurrency will become a fundamental means of transaction in the future. Therefore, for the crypto industry to comply with strict AML/KYC rules, a more standard and automated mechanism must be introduced to relieve the exchanges of this extensive administrative pressure. Possible innovations can be in the form of a simplified system where clients can get a user-friendly experience. An improved AML/KYC structure is required wherein data privacy for users is preserved and is shared only with law firms when needed and encrypted data transmission is assured.

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