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Cryptocurrencies have changed the global financial system. People across the globe can freely transact without input from banks, governing bodies, or other financial institutions. What's more, they’re able to move money around without it ever being tied to an individual person—just a wallet address.
While cryptocurrencies bring endless benefits, particularly to those with limited or no access to basic financial services, it also presents many challenges. Criminal activity, such as scams, money laundering, terrorist financing, trafficking, and exploitation, are known issues.
As adoption has increased, this little regulated space has needed to take KYC and AML compliance from traditional financial services to maintain cryptocurrency viability, trust, and transparency.
In this article, you’ll learn what Know Your Customer (KYC) and Anti-Money Laundering (AML) are, why they’re needed, and the difference they’ll make to the mass adoption of cryptocurrencies.
What Is AML (Anti-Money Laundering)?
Crypto AML is a set of procedures designed to stop criminals from converting cryptocurrencies obtained illegally into fiat currencies, leaving no trace and enabling them to remain elusive.
How Does Crypto AML Work?
AML is a set of laws that are to be followed globally. The Financial Action Task Force (FATF) is the organization that suggests these laws and began publishing cryptocurrency guidance back in 2014.
As many jurisdictions have now put these recommendations into law, it is down to companies to ensure they’re compliant at all times, particularly Virtual Asset Service Providers (VASPs). Namely, these include crypto exchanges, NFT marketplaces, and stablecoin issuers.
The purpose of AML is to monitor for suspicious activity. When red flags appear, it is the VASPs’ responsibility to pass information to relevant regulatory bodies to investigate further and make connections between the laundered cryptocurrency and real-world criminals.
Why Is Crypto AML Important?
Cryptocurrencies have been a haven for criminals looking to launder money. Due to their anonymous nature, any criminal operating with aliases and pseudonyms could easily conduct illicit activity. Billions of dollars per year are thought to be illegally processed through cryptocurrency.
However, with crypto AML, governing bodies and regulators are able to clamp down on this. By monitoring transactions and patterns closely, they can often prevent schemes before they’ve even started.
This clampdown reduces the financial incentive from criminals while making the risk even greater. As AML makes it easier for regulators to connect illicit crypto transactions to real-world identities and schemes, the people running these operations are much more likely to get caught.
What Is KYC (Know Your Customer)?
Know Your Customer is a set of practices that requires businesses, such as crypto exchanges, to capture personal information from any person opening an account.
Just as when you open a traditional bank account, you need a government-issued ID, and with technological developments, you could be required to provide face ID and biometric authentication.
These measures are not only designed to keep you and your money safe, but they’re also in place to help criminal investigators pinpoint illegal activity. In crypto, identity verification procedures are now required to establish a connection between anonymous digital wallet addresses to known criminals.
Without this, the illegal activity would be incredibly easy to carry out as all transactions would be completely anonymous, with no possible way of finding the criminals involved.
If you’ve suffered at the hand of a scammer, check out our article Steps to Take to Recover Your Bitcoin & Crypto From a Scammer.
However, the verification processes differ depending on where the cryptocurrency business or service is located. Also, many are trying to remain true to the original mission of decentralized finance and enabling customers to supply the bare minimum verification to stay compliant.
How Does Crypto KYC Work?
Often, KYC is split into three categories: CIP, CDD, and continuous monitoring.
Customer Identification Program
As explained, CIP is capturing personal and verifiable information from customers to prove they are who they claim to be. This usually includes full name, date of birth, address, and verifying documentation, such as a driver’s license or passport.
Customer Due Diligence
Vendors use background checks, look at criminal history, and investigate transaction histories to assess the risk of a new client and decide how closely their account will be monitored.
Continuous Monitoring
KYC isn’t a one-time thing. Yes, initial checks are carried out to assess the viability of a client, but these assessments must occur frequently throughout the lifetime of the client. Suspicious activity can happen at any time, and service providers are required to report everything they suspect.
Why Is Crypto KYC Important?
For mass adoption to occur, cryptocurrencies need to build trust with users and governing bodies. KYC helps them stop illicit activity, which in turn aids in preventing criminals from easily moving money. Also, it gives users peace of mind that their funds are being effectively protected.
KYC vs AML: An Overview of Similarities and Differences
KYC and AML share some commonalities yet also offer stark differences in the crypto space. Understanding the difference between KYC and AML can help you grasp their individual and collective importance in combating illicit activities.
Similarities Between KYC & AML
- Purpose: Both KYC and AML aim to prevent illicit activities like money laundering, financing terrorism, and financial fraud in the crypto industry.
- Regulatory compliance: Both processes are mandated by financial regulations and require compliance by Virtual Asset Service Providers (VASPs) such as crypto exchanges and stablecoin issuers.
- Monitoring: Both KYC and AML involve monitoring transactions to detect suspicious activities.
Differences Between KYC & AML
- Objective: The primary objective of KYC is to verify the identity of customers, while AML focuses on monitoring and reporting suspicious activities that could indicate money laundering.
- Process: The KYC process involves verifying customers’ identity and assessing their risk profile. On the other hand, AML involves monitoring transactions, detecting suspicious activities, and reporting them to regulatory authorities.
- Timing: KYC is typically a one-time process conducted at the beginning of the customer relationship, while AML is an ongoing process.
Global Verification Variations: Difference Between KYC and AML Procedures
The verification processes for KYC and AML can vary greatly based on the country where the cryptocurrency service is located. For instance:
USA
The USA follows the guidelines set out by the Financial Crimes Enforcement Network (FinCEN). All businesses dealing with cryptocurrencies are considered "money services businesses" (MSBs), which means they must adhere to both KYC and AML regulations. This includes verifying customers’ identity, monitoring transactions, and reporting any suspicious activity to the authorities.
Europe
The European Union has strict regulations under the Fifth Anti-Money Laundering Directive (5AMLD) and the updated Sixth Anti-Money Laundering Directive (6AMLD). These directives require extensive KYC procedures including verifying identity, screening against PEPs (Politically Exposed Persons) lists, and Sanction lists, as well as comprehensive AML measures.
Singapore
Singapore's Monetary Authority (MAS) enforces AML and CFT (Counter-Financing of Terrorism) regulations. Crypto businesses must register and obtain a license, implement robust KYC measures, and have an effective AML system in place.
Challenges and Criticisms of KYC and AML in Crypto
While KYC and AML procedures are critical to the legitimization and safety of the crypto space, they also come with their share of challenges and criticisms. Let's delve into them.
Privacy Concerns
As KYC requires users to provide personal information, this raises concerns about data privacy and security. Cryptocurrency was originally designed to provide a measure of anonymity and privacy, so some community members view KYC as a deviation from the principles of decentralization and privacy.
Implementation Challenges
Implementing robust KYC and AML procedures can be complex and resource-intensive. It requires sophisticated technology to monitor transactions and detect suspicious activities. Moreover, as the crypto industry operates globally, companies must navigate a complex landscape of different regulations in various jurisdictions.
False Positives
AML systems can generate false positives, flagging legal transactions as suspicious. This can create an unnecessary burden on resources to investigate these alerts and can lead to user frustration.
Despite these challenges, the benefits of KYC and AML procedures to the safety and legitimacy of the crypto space cannot be overstated. They serve as a crucial line of defense against illicit activities, fostering trust among users and regulators alike.
In Summary: The Difference Between KYC and AML
In the past, cryptocurrencies have been a preferred method of transaction for criminals of all kinds. The anonymous and untraceable moving of money has given people the freedom to conduct illegal activity. However, as the adoption of DeFi and crypto continues to grow, providers and regulators need to adopt practices that make it safer and more trustworthy for both businesses and individuals.
Understanding the difference between KYC and AML is essential, as these procedures keep all users safe, prevent illegal activity, and make cryptocurrency a viable financial system for people and businesses around the world. At Zert, we use institution-grade AML and KYC procedures to provide you with a secure crypto trading environment.
