What is KYC and why it is mandatory on cryptocurrency exchanges 

In 2024, according to Cyvers, hacks and frauds in the crypto industry resulted in users losing more than $2.3 billion. Some of the biggest crypto attacks of the year include WazirX, Radiant Capital and DMM Bitcoin with losses of hundreds of millions of dollars in each case. This is why smart contract vulnerabilities in the DeFi sphere are increasingly showing the need to implement robust identity detection and verification mechanisms such as KYC.

KYC translates to “Know Your Customer.” This customer identity verification is mandatory in most financial institutions to protect them from fraud, corruption, money laundering and other attacks.

In the world of fintech, KYC has long been the litmus test of a project's security, especially if it is involved in payment processing. In this article, we will look at all the features of the “know your customer” procedure and assess the risks associated with it.

What is KYC in the crypto industry and why is this procedure mandatory?

Over the last 4-5 years, more and more crypto projects have been implementing mandatory KYC procedures. This procedure allows the project to identify the identity of the client before they can conduct financial transactions. This protects the platform itself from fraudsters and terrorists, as well as makes it safe to store customer assets on the site. In addition, the KYC procedure allows a company associated with financial transactions to fulfill the requirements of 5AMLD, the EU's Fifth Anti-Money Laundering Directive.

In 2020, this directive defined cryptocurrency as a digital form of value that can be stored, exchanged, transferred for safekeeping, etc. The Fifth Directive also equated crypto exchanges with financial institutions. Thus crypto exchanges are now subject to legal requirements for financial monitoring, which includes mandatory KYC as part of AML.

What is AML

Anti-Money Laundering (AML) is a set of laws, regulations and procedures aimed at identifying money that has been disguised as legitimate income.

Anti-Money Laundering (AML) laws, regulations and procedures are an attempt to reduce the ease of concealing criminal proceeds. AML standards are set by The Financial Action Task Force, an independent intergovernmental organization, and are updated on a regular basis to keep pace with modern technology.

AML (anti money laundering) is necessary for more careful monitoring of transactions, checking crypto for purity, thorough risk assessment, etc.

One of the tools of AML and is the due diligence of customer data before providing KYC financial services.

How exchanges protect personal data

Of course, many users reasonably fear that transferring data to third parties will make them vulnerable to fraudsters. However, exchanges guarantee the safety of data in several ways:

Encryption and pseudonymization

The procedure of encrypting data, especially using multi-layered methods, protects information both in transmission and storage. Pseudonymization, in turn, replaces identifying data with pseudonyms, reducing the risk of personal information leaks.

Access Restriction and Physical Security

Companies implement internal policies that restrict data access to authorized employees only. Physically controlling access to data storage devices is also an important element of protection.

Restrictions and disclaimers

Despite all measures, companies recognize that 100% security cannot be guaranteed. This is reflected in their official statements and disclaimers, which point out the possible risks and limitations of the technologies used. Thus, it is impossible to provide an absolute guarantee of security.

What is required for KYC verification?

Each cryptocurrency exchange has the right to determine for itself a set of data that is required to pass KYC. Often this list includes:

• Full name
• date of birth
• e-mail
• phone number
• country and address of residence
• ID (passport, driver's license, etc.)

Additional information may also be required, including:

• social security number or tax number
• bank statement
• rental agreement
• electricity bill
• photo and bank card details

Carefully study the requirements of the crypto exchange before registering, so as not to find yourself in an uncomfortable situation already while filling out the necessary data.

How does KYC verification take place?

The KYC process usually involves several stages:

Client Verification

The KYC procedure itself is a mandatory step for registering a new client with the exchange. At this stage, it is necessary to confirm all the data that is specified on the website (name, date of birth, e-mail, phone number, country of residence and so on).

Then the company thoroughly checks all the information provided and verifies it with the databases it has. The amount of time spent on verification can also be different, as different exchanges operate different amounts of databases.

Customer verification

After verifying the data provided, the platform assesses the risk of illegal activities. For this purpose, certain watch lists are usually used: (global lists of politically exposed persons (PEP), relatives and close associates (RCA), persons/organizations of special interest (SIP/SIE), lists of particularly dangerous terrorists and so on).

Also at this stage, the platform will definitely look into your credit history, transaction history and determine your geographical location. Business clients may require an extended list of actions to be investigated, which you will be notified about in advance.

Advanced Customer Due Diligence

At this stage, the platform dives even further into your financial activity data to assess risks even more accurately. This stage may include researching the origin of funds, monitoring transactions, and other more detailed financial history research. Only high-risk customers are typically subjected to this kind of scrutiny.

Regular customer monitoring

All business profiles with suspicious activity continue to be subject to regular verification by the crypto exchange. Platforms are constantly analyzing new partnerships, activity, media mentions, and any other significant manifestations.

It's worth noting that the number of KYC steps on each exchange can vary and is usually listed on the exchange's website.

What is KYC on Binance?

Binance requires customers to undergo a Know Your Customer (KYC) process to verify their identity, which ensures the platform's compliance with regulatory standards and enhanced security.

In order to go through the KYC process on Binance, you need to:

1. Select a verification level

Binance offers two levels of KYC customer verification: Level 1 (basic) and Level 2 (full). To get full access to all features, including increased withdrawal limits, you need to pass Level 2 verification.

2. Complete the identity verification form

When verified, you will need to provide personal information and upload documents to verify your identity.

Personal Information:

• Full Name
• Date of Birth
• Citizenship

Proof of Identity:

• Upload a clear image of your government-issued ID (passport, national ID card or driver's license).
• You may also be asked to take selfies with your ID to confirm that you are the same person as in the photo.

3. Provide proof of address (if required)

For Level 2 customer verification, you will need to upload a proof of address document. Examples include:

• Utility bills (electricity, water, gas)
• Bank statements
• Tax documents

The document must be recent (usually within the last 3 months) and clearly show your name and address.

What is "Dirty" Bitcoin

"Dirty" bitcoin is bitcoin that has been used in illegal transactions. Major crypto exchanges try to verify the origin of the currency very carefully, track and block “dirty” coins obtained by criminal means.

Services such as Chainalysis and AMLBot are very accurate in identifying “dirty” bitcoins. These platforms have huge databases that allow them to trace most dirty currency with a high probability.

Checks usually take anywhere from a few seconds to a few minutes.

“Dirty” bitcoin is dangerous because it can compromise all the other coins in your wallet as well. To regain access to your funds, you will have to undergo verification (AML/KYC procedures), as well as explain the origin of the coins.

Conclusions

KYC and AML procedures are still a lively debate among cryptocurrency users, as they contradict the very basic idea of cryptocurrency anonymity. In addition, many customers are concerned that after verification, their data could fall into the hands of malicious actors, causing their assets to suffer.

However, KYC/AML has many more benefits, including reducing the risks of crypto being used for illegal purposes, protecting the user from many types of scams, the ability to regain access to the account, access to a wide range of centralized exchange functionality, etc.

The most important thing is to resurvey the crypto exchange, familiarize yourself with its rules and learn about all the data requested during registration.Determine whether the securitization level of the exchange and the set of required documents for registration suits you - and only then start the KYC procedure.