Know Your Customer Regulations in Crypto Exchanges

Over recent years, buying top digital currencies such as for example Bitcoin and Ether is common in off-exchange trading. The using digital assets at a corporate level is quite promising. The cash management is revolutionizing, which can be revamping the standard payment flows using blockchain. Here is how to know the “know your customer” regulations in the crypto exchanges.

Corporate banking entities work with a distributed ledger where most of the transactional information is stored.

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An end-to-end process pledges an amount of assurance to all the parties which have participated in the fund pool and their security. Digital currency services have eliminated the intermediaries and reduced the price of all the payment transfer infrastructure for transaction records and security.

Before diving deep, let’s look into the kinds of exchanges active today in the crypto market:

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Crypto exchanges are split into two major groups: “fiat-to-crypto” and “crypto-to-crypto” exchanges.

Fiat-to-Crypto Exchanges

The exchanges perform ‘due diligence measures’ while they deal with the fiat money. The exchanges are required to conduct business with financial institutions.

It’s therefore required to perform stringent KYC procedures to make sure a clean customer base before using the services of the entities. In fiat-to-crypto exchanges, fiat money enters into the market of cryptocurrency.

The exchanges allow exchanging the fiat currency with the supported digital assets. For exampl,e dollars for ether.

Crypto-to-Crypto Exchanges

The crypto-to-crypto exchanges enable the users to switch one cryptocurrency for one other. These are online platforms like stock/currency exchange. Here, buyers and sellers trade are performed based on the current price in the cryptocurrency market.

Exchanges play as a middle-man. One cryptocurrency is exchanged with another type of cryptocurrency to get profit.

Other than the Bitcoin and Ether, there are other altcoins, and also to buy them, people will need a crypto exchange. The exchanges are a significant component of the complete crypto market. The investments, buying, and selling happen through a crypto exchange being an intermediary.

Investors and stakeholders are facilitated through exchanges. Now, most of the time unwittingly, bad actors participate in the crypto network and perform financial crimes such as for example money laundering and other malevolent activities.

The worldwide regulatory scrutiny has pinpointed the crypto exchanges to endure stringent ‘customer due diligence’ measures to deter the chance of financial frauds.

The fifth Anti Money Laundering Directive (AMLD5) has clearly declared the need for identity verification measures of every customer prefer to participate in the crypto exchanges. AMLD5 obligations include Know Your Customer (KYC) compliance, Anti Money Laundering (AML), and Combating the Financing of Terrorism (CFT) compliance.

Crypto exchanges across the globe have to verify each onboarding customer against the identity verification parameters to make sure that no bad actor is facilitated. Such critical concerns make KYC and AML compliance mandatory for the crypto exchanges that ensure a filtered clean customer base.

Components of Know Your Customer

KYC describes a set of processes and procedures adopted by businesses to recognize and verify the identity of onboarding customers to deter the chance of fraud and final crimes. KYC fundamentally incorporates four elements: identification procedures, acceptance policy, risk management, and transaction monitoring.

The concern of the KYC verification process in cryptocurrency is really as a result of money laundering. Through stringent identity verification procedure, crypto exchanges can combat the acts of terrorism and money laundering. KYC verification includes verification of an individual from the collected information such as name, address, date of birth, etc.

How crypto exchanges approach regulatory obligations?

As per regulatory compliance, KYC verification has to be done through the customer lifecycle. A distributed ledger or blockchain is really a complex infrastructure that holds the record of all transactions.

Using strong cryptography, the blocks are encrypted to make it hard for an unauthorized entity to gain access to it or temper it. There really are a total of four levels in which KYC verification is divided. These are:

Customer Acceptance Policy (CAP): In this stage, an organization makes a document containing the details on such basis as which customer is permitted to make a relationship with its clients. The company selects a person only if their identity is credible and is found appropriate after assigning a risk rating in the process of customer research.

Customer Identification Program (CIP): This is really a stage in which customer identification is performed to ensure that an organization can carry on financial transactions with a person.

Risk Management: Customer identification is performed and a rating is given to the profile according to the risk from the customer.

Continuous Transaction Monitoring: Throughout the consumer lifecycle, transactions should be monitored continuously to recognize suspicious transactions if any.

The current state of regulatory compliance in Crypto Exchanges

With respect to compliance, the present situation in crypto exchanges is not that satisfactory or we could say it’s not according to the obligations of regulators. It is studied that two-third of crypto exchanges fail to strongly comply with the regulations. They have a vague understanding regarding molding the operations according to the requirements.

Crypto exchanges request name, email, and contact number, nothing else, which can be not enough information for customer verification. This is the reason that banks and financial institutions prefer not to assist crypto exchanges.

After the evaluation, it is unearthed that some crypto exchanges now ask primary documents from the customers like a photograph, passport, and a written certificate. However, these pieces of information might not be enough to conduct a proper KYC procedure.

Some exchanges perform low-level compliance, for instance a crypto exchange, Binance asks its customers to supply a passport at the time of sign-up. With this, security concerns about user personal data collection are raised. However, some exchanges do not even ask for these records.

Reasons why crypto exchanges overlook compliance procedures

Regulatory scrutiny has shown deficiencies in adoption of regulatory demands in cryptocurrency exchanges. Following are the explanations why crypto exchanges do not consider regulators:

  • The crypto market is in full swing. The competition between the pool of exchanges disregards the regulatory obligations. Ther clients find KYC procedures cumbersome due to which exchanges prefer not to include them in their operations.
  • KYC compliance is a time taking process. It takes hours for crypto exchanges, the same as commercial banks to perform customer due diligence that increases customer drop-out rate.
  • The cost to undergo KYC procedures in an organization is too much. Banks are already spending millions of dollars annually on ‘due diligence’ measures. The similar norms to take into account as compliance charges for crypto exchanges can become critical.
  • There are vague statements. Crypto exchanges find hard times in analyzing certain requirements of KYC and AML regulations in the light of virtual assets. Whether the industry is meant to undergo KYC compliance, precisely the banks do or there s some leverage.
  • Regulatory bodies such as for example FATF and AMLD5 enforce the adoption of KYC/AML/CFT compliance on virtual currency service providers that perform ‘customer due diligence’ measures. For example, from identity verification to transaction monitoring and record-keeping to reporting suspicious transactions. Further elaboration for crypto exchanges is required by regulators to behave accordingly.


The very complex financial infrastructure of blockchain is out of the scope of regulators who face a hard time understanding the flow. However, the anonymity factor in the cryptocurrency paves the paths for criminal activities for whom the platform just isn’t less than a haven.

Similarly, financial crimes such as for example money laundering and terrorist financing are facilitated through them as a result of which crypto exchanges are under the red zone of regulatory scrutiny. As per regulatory requirements, there is a dependence on proper KYC/AML procedures in the crypto industry to create it transparent in the complete financial market.

Crypto exchanges are in need of the proper direction and clear testaments by regulatory authorities according to the compliance requirements. However, still another challenge of balancing the high compliance costs may be solved through the use of the third-party compliance solutions that align according to the requirements of worldwide and local regulators.

If one crypto exchange takes the initiative of adherence to compliance, to maintain the reputation, other cryptocurrency platforms would definitely contribute their devotion and cost to such measures.

James Efron

James Efron is really a tech enthusiast, currently serving as infosecurity management expert at Shufti Pro . He has been involved in designing organisational strategies for tech firms, and is often found assisting digital transformations.

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