What is KYC? – How Centralized Crypto Exchanges Prevent Money Laundering

If you have used a centralized crypto exchange, it is likely that you performed a KYC (Know-Your-Customer) check when signing up. A KYC check simply means verifying your identity to enable a crypto business to stay compliant with AML (anti-money laundering) regulations.

For regulators and states, the KYC requirement is an essential tool for prohibiting criminals from using crypto to conduct illegal activities like money laundering, terrorist financing, and human trafficking.

What are AML and KYC, and Why Do They Exist?

KYC procedures are used to confirm the information submitted by a customer in order to restrict the creation of a fraudulent account. Usually, KYC intends to understand the kind of business a customer is involved in, their source of funds, and determine if they pose any money laundering risks.

KYC policies in the United States were established back in the 1990s to help curb money laundering. They require customers to submit their official names, email addresses, proof of residence, and photos of identification cards.

On the other hand, AML policies are intended to block criminals from using exchanges or banks to launder crypto or money.

Last August, when the US Treasury decided to sanction coin mixer Tornado Cash, the agency cited that criminals used it to launder proceeds from illegal activities.

AML policies in the United States were established in 1970 under the Bank Secrecy Act. The Act requires companies to maintain records that law enforcement authorities can use to identify money laundering and prosecute the culprits.

KYC and Crypto

Crypto exchanges like Binance, Coinbase, Kraken, and Gemini use ‘Identity Verification’ to ensure they are compliant with KYC regulations. Therefore, any customer wishing to sign up with one of these exchanges is required to provide their personal information.

Coinbase, for example, states on its website that, being a regulated crypto exchange, all customers must verify their identity to use the company’s services.

While KYC and AML policies are put in place to protect the financial system and consumers, many privacy advocates believe such policies violate the right to privacy in case a crypto firm files for bankruptcy. This is because the information submitted by customers is made public as court records.

For example, when crypto lending firm Celsius filed for bankruptcy last July, it gave its users’ personal and account information to the court. When the data was published, it became possible to identify an on-chain activity with a specific individual.

KYC and Web3

Most Web3 enthusiasts have expressed concerns over revealing their identities and location, with many proposing a limited identity verification procedure.

Civic, a San Francisco-based company, provides Web3 fans with solutions for online identity through its Civic Pass product. This platform allows users to manage their NFT, online identity, and wallet addresses from one place.

Other projects aiming to provide KYC services for the Web3 community include Parallel Markets, Astra protocol, and Polygon ID. Each promises to deliver a seamless identification process.

KYC remains a sensitive topic in the crypto industry, considering that it is a space built on principles of permissionless transactions and privacy. However, with the growing interest from governments to regulate the industry and the traditional financial system becoming more integrated with blockchain, it appears that KYC will be here for a long time.

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