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In the last few years, the Know-Your-Customer verification process has become vital to comply with the AML (Anti-Money Laundering) and Combating-Financing-of-Terrorism efforts. Cryptocurrency transactions are anonymous and are used worldwide to take part in financial fraud. To reduce these types of frauds, AML/KYC compliance is required. 

While AML regulators have targeted “traditional” money laundering since the 1930s, current AML operations aim to ensure that digital assets like cryptocurrencies don’t outpace the regulatory requirements that traditional financial assets are subjected to. Up until now, the cryptocurrency industry has tried to boost AML efforts by employing KYC and Know-Your-Transaction processes to verify the real people behind digital identities and the origins of the transactions. However, new regulations since 2018 by leading AML watchdogs such as the Financial Action Task Force (FATF) are focusing on digital assets like cryptocurrencies.

In this article, we’ll take a closer look at how KYC/AML works in the cryptocurrency market. What the limitations are and how the changes impact the crypto industry. 

History of AML Regulations

Global AML regulation is heavily influenced by the policies that shape the United States’ way of fighting against money laundering. The cornerstone of the U.S’s fight against money laundering are two main acts, the foundation is built upon the “Bank Secrecy Act” and the “Patriot Act”. Both these acts were created to fight money laundering and terrorism funding. 

It wasn’t until the release of title 3 of the USA Patriot Act (also known as the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 that the implementation of Know Your Customer which helps businesses identify whom they do business with. 

The patriot act catered towards eradicating the funding of terrorism using the financial sector. Due to the United States’ influence on the world economy, its KYC measures soon spread globally, leading to huge reforms in the world’s most eminent financial jurisdictions. 

In 2018, FinCEN’s Customer Due Diligence Requirements for Financial institutions changed BSA regulations.

AML vs KYC: How are They Different?

AML and KYC are often combined and used interchangeably in the financial sector, this isn’t exactly accurate. Both of them offer risk-based approaches to money laundering, but both the AML and KYC regulations work together to whitelist customers, manage risk, and monitor transactions. 

The confusion between what constitutes AML and KYC is full of errors for financial institutions. Companies have to ensure that they incorporate a comprehensive AML program, not only KYC. Anti-Money Laundering is a complex framework of strategies, rules, and regulations to combat money laundering. 

KYC is essentially a small part of the overall AML process, which helps financial institutions verify the real identities of their customers. AML regulations require companies to submit risk reports, perform diligence processes allowing a new customer to sign aboard. 

What is Anti-Money Laundering (AML)?

Anti-Money Laundering (AML) is a comprehensive set of processes, regulations, and rules that together cohesively combat money laundering, terrorism funding, and financial crimes. 

The end goal of AML compliance is to detect and disrupt money laundering, this is usually broken down into 3 stages: Placement, Layering, and Integration. 

Led by the regulatory body Financial Action Task Force (FATF), countries all over the world develop their measures to combat domestic money laundering, and policies can differ from each country. A financial institution’s AML policy should follow through with the domestic AML regulations. 

• KYC procedure: Customer Due Diligence (CDD) & Enhanced Due Diligence (EDD).
• Risk-based anti-money laundering policies.
• Ongoing risk assessment and monitoring
• AML compliance training for company staff
• Internal audits and controls

What Are The Objectives of KYC?

The KYC regulations help organizations from all over the world mitigate the risk of intentional or unintentional exploitation of bad actors. This can even prevent businesses from the risk of money laundering and terrorist funding. It also creates a better understanding between the customers and its customers. 

When conducting a KYC assessment before doing business with a new customer, financial institutions need to look at just two elements. The two facts are:

• Facts
• Behavior

How is a KYC Policy Created?

Companies that implement KYC usually build their policy around 4 core pillars:

• Customer acceptance policy
• Customer identification procedures
• Monitoring of transactions
• Risk management

Based on these foundations, a KYC investigation normally involves the following parts:

• Collecting and studying personally identifiable information, known in the U.S as CIP (Customer identification program).
• Screening of the PII (Name, Address, birth date, and more information about the customer) against worldwide AML/CFT or Politically Exposed Person list. 
• Determining the risk a customer poses in terms of money laundering, terrorism funding, and other illegal customer behavior.
• Creating and assessing a client profile based on their financial history.

Who Needs to Comply with KYC? 

To verify and identify a new potential customer, financial institutions like banks need to check a user’s identifying documents. Here’s detailed information about what is required from different parties:

KYC and Customers

First off, new customers will need to submit requested documents, some of the most common documents are:

• Photo ID documents issued by the government
• Driver’s license
• Passport
• Voter identification card
• Social security number
• Permanent Account Number (PAN) card
• Utility bill
• Recent bank statement
• Rental agreement

KYC and Crypto Industry

With the KYC industry still taking its baby steps and highly unregulated, it took a lot of time for KYC procedures to make their appearance. 

However, FinCEN’s recent definition of many crypto-related enterprises stated that crypto businesses have to comply with the Bank Secrecy Act. Non-compliance can lead to huge fines. FinCEN has also proposed the regulation of private wallets that deal with exchanges in 2021. For these private wallets, stronger KYC methods have to be applied.