KYC and Bitcoin: What You Need to Know

Cryptocurrencies are an increasingly popular financial asset. According to data provided by CoinMarketCap, the total global value of cryptocurrency exceeds $1 trillion in June of 2022. While there are more than 15,000 cryptocurrencies, the most prominent digital currency—Bitcoin—still accounts for nearly half of the total value of global crypto-assets.

Gone are the days when Bitcoin and cryptocurrency could be thought of as the “wild west” of finance. They are now mainstream assets that are subject to a range of financial regulations, including KYC verification. In this article, you will find an overview of the most important things you should know about KYC and Bitcoin.

Know the Basics: What Is KYC and Why It Matters

To understand KYC and Bitcoin, you first need to understand the history and purpose of KYC in general. KYC (know-your-client or know-your-customer) is a set of legal regulations that apply to banks and financial institutions. The modern KYC regulations arise largely from the anti-money laundering (AML) rules found with the Bank Secrecy Act of 1970, the enhanced financial regulations from the USA Patriot Act of 2001 and the EU AML Sixth Directive (AMLD6)

The basic purpose of KYC regulations is relatively straightforward: Banks and other financial entities have a legal duty to know who they are working with. Beyond that, they should be able to confirm that their customers/clients are “safe.” The KYC rules are designed to stop the funding of terrorism, drug, distribution, financial fraud, and other illegal schemes. A company or organization that fails to comply with KYC could face serious sanctions, including stiff financial penalties.

Note: KYC requirements for Bitcoin (and more traditional financial assets) are not limited to the United States. Many other countries, including the United Kingdom (UK) and the countries within the European Union (EU), have their own standards in place.

Understanding What KYC Entails

KYC requires banks, lenders, and other financial entities to know their clients/customers and to make sure that they are reasonably safe. You may be wondering: What does KYC mean in practice for Bitcoin and other cryptocurrencies? The short answer is that a properly designed KYC system is a multi-step verification process. Here are three key steps for KYC and Bitcoin:

  1. Collect PII: KYC starts with the collection of Personal Identifiable Information (PII). At a basic level, PII includes a customer’s full legal name, date of birth, and current address. The information can be confirmed with two separately acquired data sources (“2+2”) or official documents then cross-referenced with the appropriate databases to ensure that the customer is who they represent themselves to be.
  2. Analyze Purpose: Once a Crytocurrency customer is confirmed to be who they say that they are, KYC involves a basic review to ensure that they have reasonably legitimate purposes. This means conducting an assessment of the client. As an extreme example, a cryptocurrency exchange would not want to offer a Bitcoin account to a domestic or foreign national that is facing serious terrorism charges.
  3. To accomplish this important AML function, Financial Sanctions and PEP lists must be checked.    This is best accomplished at the KYC step.    This is a critical step.
  4. Ongoing Monitoring: Finally, a well-designed KYC process generally involves some ongoing monitoring of a Bitcoin customer that has been classified as high risk or a PEP hit.. A customer may be deemed at higher risk if they make a large number of deposits, make frequent transactions, or are connected to accounts that have been flagged by authorities. Some form of ongoing monitoring can help companies ensure compliance with the requirements under the law.

Financial Institutions in the Cryptocurrency Industry Are Not Exempt From KYC

Know-your-customer is a real challenge for banks and other financial institutions that offer services in the Bitcoin or cryptocurrency industry. After all, the anonymity of Bitcoin has long been one of its selling points. It is also something that has drawn the attention of government officials. Indeed, earlier this year, a report in The New York Times noted that the relative anonymity of Bitcoin and other cryptocurrencies was raising alarm bells among regulators and law enforcement agencies.

It is important to emphasize that there is no special KYC exemption for Bitcoin or other cryptocurrencies. In October of 2019, U.S. regulators (SEC, CFTC, and FinCEN) issued a detailed statement on cryptocurrency and AML. They clarified that cryptocurrency exchanges that accept U.S. customers are subject to U.S. KYC rules and AML regulations. Financial entities that work with Bitcoin and accept American customers—whether a more traditional institution or an offshore cryptocurrency exchange—should be prepared to comply with KYC requirements.

Bitcoin and KYC: Many Cryptocurrency Exchanges Are Falling Short & At-Risk

As reported by Coindesk, by late 2019, only 26 of more than 200 cryptocurrency exchanges that were reviewed had adequate KYC and AML verification systems in place. While other exchanges have caught up since that time, the reality is that there remain serious gaps in the industry. Many financial institutions and cryptocurrency exchanges could face the risk of sanctions from U.S. regulations for lack of KYC compliance and/or lack of AML compliance.

Know-Your-Customer Verification Does Not Mean a Loss of Client Privacy

Although many in the Bitcoin community—from customers to financial institutions—are understandably skeptical of KYC. The reality is that there are strong KYC and AML regulations in place in the U.S. market. Financial entities that fall out of compliance are at risk of serious legal liability. That being said, complying with KYC verification standards and AML regulations does not mean that institutions must completely sacrifice customer/client privacy. Quite the contrary, companies and organizations can still put strong processes and systems in place to ensure that the privacy of their clients is strongly protected. The institution simply needs to know the identity of that customer.

Integrity Is a Leader in Know-Your-Customer Verification

A division of Aristotle, Integrity offers a wide range of reliable KYC, identity and age verification. We are committed to providing narrowly tailored solutions that work effectively for our clients. If you have any specific questions about KYC and Bitcoin, our team is here as a resource. To learn more about how we can help with your Bitcoin or other cryptocurrency-related KYC needs, please do not hesitate to contact us today.

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