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Know Your Customer (KYC) is the process that financial institutions such as banks use to verify the identity of customers or clients as part of anti-money laundering (AML) and counter-terrorist financing (CTF) efforts. KYC procedures involve collecting specific information about individuals or entities before they can open accounts to engage in financial transactions.
The primary objective is to ensure that these individuals or entities are legitimate and not involved in any illegal or fraudulent activities such as money laundering and the misuse of financial accounts.
When opening a new account with a service provider, you will likely need to complete a KYC check before you can proceed.
Techopedia Explains
The Financial Action Task Force (FATF), an international organization founded in 1989, sets the standards for combating money laundering such as KYC. Its mandate was expanded in 2001 to include terrorist financing.
The key components of KYC are:
- Identity verification. To open a new account, individuals are required to provide valid government-issued identification, such as a passport, driver’s license, or national ID card, to confirm their identity.
- Address verification. Proof of address, such as utility bills or bank statements, is required to confirm the customer’s place of residence.
- Customer due diligence. Financial institutions and businesses must perform thorough due diligence on their customers. This includes assessing the customer’s risk profile, business activities, and the source of their funds.
- Ongoing monitoring. KYC is not a one-time process. Financial institutions and service providers are required to monitor customer transactions continuously to identify and report any suspicious activity.
KYC in Cryptocurrency Markets
The decentralized nature of cryptocurrencies initially allowed the markets to operate with some anonymity. However, financial regulators around the world have recognized the need to bring these markets under their oversight to deter illegal activities.
As a result, KYC procedures have become increasingly prevalent in the cryptocurrency sector.
Most reputable cryptocurrency exchanges now require users to complete KYC procedures before they can open an account to deposit, trade, or withdraw funds. Users are typically required to submit identification documents and undergo identity verification. This helps exchanges comply with AML and CTF regulations.
Crypto projects launching initial coin offerings (ICOs) or token sales often implement KYC procedures to ensure that contributors are not engaged in illegal activities. This also provides transparency to investors and builds trust in the project.
While decentralized finance (DeFi) platforms aim to eliminate intermediaries, some of them are also implementing KYC measures – particularly decentralized exchanges (DEXs) and lending protocols that want to comply with regulatory requirements.
Some cryptocurrency wallet providers may also require users to complete KYC, especially if they offer services that involve fiat-to-crypto conversions or access to DEXs.
Keep in mind that there are highly-rated crypto exchanges that don’t require identity verification, but the fees may vary.
The Bottom Line
Know Your Customer is an important tool designed to deter illegal activity and maintain the integrity of the financial system.
In the cryptocurrency market, where anonymity was once a hallmark, KYC procedures have gained prominence as regulators seek to strike a balance between innovation and security.
As the regulation of the crypto industry continues to evolve, KYC will likely remain a central aspect helping to legitimize the sector and protect users from fraudulent activities.
