Know Your Customer

Cryptocurrencies are by now an established global presence and continue to generate excitement and disruption in the financial sector.

The rising popularity of digital coins has generated almost daily news snippets on some aspect of virtual currencies. Mostly the bad news prompted regulators during 2017, especially as speculation in bitcoin soared, to take a formal look at the digital asset sector and apply legislation that would safeguard participants.

It is unfortunately true, though no intrinsic fault of digital currencies, that the phenomenon does enable a new kind of criminality. On the one hand, security is generally watertight in the industry. On the other, if a successful hack or phishing attempt manages to steal funds, they are lost forever.

There is no arrest and prosecution of wallet addresses, and the anonymity of cryptocurrency most often means that stolen funds remain visible on the blockchain, yet untouchable. With such dire potential loss a possibility, especially in an unregulated space succumbing to massive speculation, regulators across the world channeled their alarm into formulated protocols to govern everyone’s best interests in the digital coin universe.

Anti money-laundering legislation (AML) and Know Your Customer (KYC) laws have a wider origin and focus than cryptocurrencies, but the most visible manifestation of their implementation happens in the digital coin world.

KYC stipulations have been a bugbear for many enthusiasts, as they see their anonymity crumbling, but fiduciary duty and caution have prevailed. Although even six months ago there was widespread fear that regulation was either a veiled attempt by legacy money to quash digital coins, or that it could quite possibly spell the end of blockchain money in practice, outcomes have been benign. In anything, regulation has reassured users and ultimately will contribute to the standing (and adoption) of digital currencies.

Knowing Your Customer

KYC seeks a process of collecting pertinent, identifying information about the users of a service. In applying KYC, the platform or company providing the service will compel all users to submit (internationally recognizable) identify documents. User photos, identity card or booklet, residential address (with a confirming utility bill displaying name and address) credit card and bank account information all typify the kind of information required by KYC laws.

Although KYC is seen as “soft” or civil regulation, the protocols are in fact laws, enforced by industry bodies and law enforcement alike. The core purpose of KYC is to make sure people are disqualified to partake of a service – either through being underage, illegal resident or criminally motivated – remain precluded from participation.

KYC also generates a database that is useful to both parties. Law enforcement can identify and pursue criminals or terminate the service provision to minors, but users can also employ the database to validate their presence and participation.

KYC has existed for many years in various guises in the forex, gaming and other arenas, and has been an integral component of legacy fintech for years too. AML is closely aligned and indeed indistinguishable in application at times, but has a longer term reach. AML laws exist to inhibit criminals from turning their illicit gains into legitimate, “clean” money.

As society has progressed, a symbiosis has developed between government and the banking sector to effectively develop and apply AML legislation. This relationship borne of necessity has produced what users today recognize as banking and banking protocols, although AML does stretch further than banks and cash, encompassing other avenues of laundering stolen goods. The legacy arena is full of checks and balances that attempt to close routes to criminal deceit.

Cryptocurrency Gets Regulated

It was inevitable that digital assets come under the same scrutiny fiat money at some point. Crypto is money and, although digitized, attracts identical issues as fiat in almost every way. KYC and AML legislation stipulates that users identify themselves adequately, yet run counter to a fundamental tenet of blockchain coins.

An inseparable component of cryptocurrencies is their anonymity, epitomized by a coin like Monero, that actually makes a marketing ploy of its intense anonymity. The majority of users feel that, cryptocurrency transactions should be completely anonymous, seeing identification as akin to control, and virtual coins were expected to do away with control as a principle.

From a regulation perspective, digital currencies open up the prospect of the very worst kind of criminal abuse of such a decentralized and anonymous system. ought to be anonymous and untraceable which is a big headache for regulators as there are fears that criminals could take advantage of such a system.

Terrorism, Real Or Imagined

Many opponents of digital coins talk of “ML/TF” when spurning the ecosystem of virtual currencies. This stands for “money laundering and terrorist funding.” when law enforcement agencies can’t trace and track the movement of money, the financial and overall well-being of a country’s citizens could be severely threatened. Unavoidably, KYC legislation wants the cloak of anonymity removed from cryptocurrency. For many, this is fundamentally opposed to the essence of digital coins, and the battleground is still silently raging.

Regulatory responses have been varied across the world, although broadly moderate as a global phenomenon. They have ranged from China’s outright banning of all things crypto to other countries simply pasting existing KYC regulation onto emerging digital exchanges.

Digital Crypto Exchanges

The most visible “nodes” where crypto appears in all of its grandeur are cryptocurrency exchanges. These platforms present a marketplace where users can buy, sell and trade digital assets. Just like the forex market, crypto traders pair digital and sometimes fiat currencies with one another, trading on fluctuating values. Many crypto traders are also HODLers – investors who sit on coins in anticipation of a future price spike.

For a user to employ a digital exchange, they will typically nowadays need to sign up with preliminary details like a name and mail address onsite. Often depending on the nature of the exchange and the user’s needs, preliminary identification is sufficient. Most of the time, however, far more detailed and authenticated intel needs to be submitted to enable trading. Many exchanges across the globe have experienced modest to severe notices to comply with KYC laws, as the first half of 2018 saw the legislation finally settle on the industry.

That said, many P2P exchanges and even some comprehensive exchanges elude KYC application due to the nature of their service, or by passing the buck to payment solution providers affiliated to the platform.

For the majority, however – those that act as a legacy exchange facsimile in the digital arena – KYC has meant that they have had to turn protocols around somewhat in order to comply. Whereas before a crypto trader could float in and out exchanges without much verification, only encountering KYC on large money movements, the standard has changed. Now, KYC comes before any user can trade, whether in volume or not.

An anonymous trading account is becoming a rarity, as governments all over the world either ban or far more strictly monitor digital trading accounts. South Korea, for example, prohibits anonymous trading accounts on principle. On the plus side, at least for all parties untroubled by KYC, digital exchanges are a logical focus point for spreading the regulation throughout the crypto arena.

The Worst Examples Linger

The Charlie Shrem incident of 2014 highlights a classic case regulators fear will proliferate without KYC governing the cryptosphere. Shrem was a minor crypto celebrity and a very recognizable figure in blockchain and crypto circles, who ended up serving a prison sentence for his role in crypto-style money laundering.

Shrem’s criminality also touched on the infamous darknet Silk Road marketplace. Shrem was sentenced for aiding associate Robert Faiella in laundering $1 million in bitcoin which was subsequently used to buy illicit goods. He was also found to have failed to report many suspicious activities on his digital BitInstant exchange. After serving two years, Shrem was released in 2016.

The moderates like the US, South Korea and the EU have now mandated KYC and AML legislation as a component of all digital currency frameworks. Working with the European Central Bank, the European Parliament in 2017 passed legislation forcing visible and entrenched KYC and AML rules onto the industry. Others like Japan and France have been less intense, although similarly regulatory, by improving variable  KYC and AML legislation as applied to local crypto exchanges.

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