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What is KYC?
1/25/2022
What is KYC?

KYC or Know Your Customer (sometimes Know Your Client) refers to a set of rules and obligations that financial institutions must adhere to in jurisdictions like the USA, EU, Australia, and many more. These measures are put in place to help fight money laundering and other financial crimes.

The specifics of KYC start with a background check using a government-issued photo ID. Oftentimes a passport, bank statements, and more may be required. These documents are then checked against relevant databases in order to verify their authenticity. Once documents are verified, it is often required that the user takes a photo of themselves within the application where they are going through KYC. This image is then compared to their photo ID in order to ensure that the person signing up is the same person whose documents are being submitted. 

KYC in Crypto

The nature of decentralization can make KYC difficult. Peer-to-peer transfers without centralized middlemen offer an inherent level of privacy and a lack of oversight. Blockchain technology has a level of transparency built-in, every transaction is on a shared ledger for all to see. However, wallet addresses aren’t easily connected to individual identities. Regulators have taken to monitoring fiat on-ramps, places where you can turn traditional currency into cryptocurrencies. These are almost exclusively centralized exchanges, as decentralized exchanges are for crypto to crypto transactions only. 

Regulatory Requirements Today

KYC requirements have become commonplace in the centralized exchange space. Most exchanges require you to sign up and complete KYC before you can start transacting. These requirements have come on the heels of strict government crackdowns across the world. In the UK for example, regulators forbade Binance from operating due to a lack of approval from the countries’ regulatory bodies. Japanese regulators also stopped Binance from operating in the country for similar reasons. 

Meanwhile, Coinbase has implemented a strict KYC protocol in order to comply with US regulators and serve the US market. Coinbase didn’t require KYC for years, however as regulation surrounding cryptocurrencies has changed, so have the requirements for exchanges. 

Many exchanges serve only certain countries or jurisdictions in order to ensure compliance. Some exchanges such as BitMex were brought up on charges for serving US clients without following KYC law. BitMex was an especially desirable target for the US government as they were allowing derivatives trading on the platform which is a highly regulated industry in the US. 

The SEC has put out statements on DeFi but has not yet put out regulations surrounding DEX’s. Should the US attempt to regulate decentralized protocols we can expect to see a big battle between governments and the crypto community. 

Another interesting outlet for purchasing crypto from fiat without KYC is bitcoin ATMs. These have been the target of regulations recently. They are now subject to FinCEN regulations. The bitcoin ATM industry is fighting these - some owners have started the Cryptocurrency Compliance Cooperative in order to attempt to guide regulation around that side of the industry. 

What does the Future of Crypto Regulation Look Like?

The crypto community is very split on how they’d like to see governments react to blockchain, DeFi, and Web 3 in general. Many in the crypto space believe that government regulation is antithetical to the nature of decentralization and blockchain technology. Some are afraid that missteps by regulators will slow or halt development in the space. Others are afraid that some of the core principles of decentralization, such as equal access for all, will be destroyed if regulators put forth rules similar to what is in place for accredited investors today. Accredited investors are a class of investors who earned more than $200,000 per year for the last 2 years, or has a net worth over $1 million. Only accredited investors are allowed to invest in specific types of investments. Frequently startup funding rounds are only opened to accredited investors. Many see this as a privilege of being rich and aren’t supportive of other classes of investors being left out. Should these rules extend into the crypto space, many worry that fair launch practices and other forms of governance created to allow for equitable distribution of tokens may be left behind.

Will KYC Benefit Average Crypto Users?

Overall, concerns about KYC may come from many different sides of the crypto industry. To many exchanges, KYC both makes sense and legitimizes the companies. Coinbase has tried to be the leading compliant consumer-facing exchange. It’s no surprise that as a result, they have become the largest exchange in the US. With regulation comes crackdowns on fraudulent and malicious players. Most of the retail crypto community should be supportive of KYC requirements and soft regulation as those are both signs of government acceptance of the cryptocurrency industry.