As with any enterprise offering digital financial services, the cryptocurrency industry needs certainty that its customers are who they say they are. Ensuring that only legitimate individuals use the system is essential to keeping it free from fraudulent activities.
The crypto market has risen in popularity in recent years, in part due to the COVID-19 pandemic. It is forecasted to grow from $1.63 billion in 2021 to $2.73 billion in 2025 at a compound annual growth rate (CAGR) of 13.8%.
Corresponding to this market’s expansion, illegal activities facilitated through crypto have also increased over the past few years.
According to the US Federal Trade Commission (FTC), nearly 7,000 consumers have reported financial losses to cryptocurrency scams amounting to more than $80 million from October 2020 to May 2021. This data is about 12 times the number of reports and about 1,000% more in reported financial losses than the figures recorded before the aforementioned period.
Other crimes carried out through crypto include ransomware attacks, theft, terror funding, and money laundering. Consequently, these alarming incidents have urged regulatory bodies to implement more stringent policies to address these issues.
Legislation such as the EU’s fifth Anti-Money Laundering Directive (5AMLD) and the US’ reform of the Bank Secrecy Act (BSA) under the Anti-Money Laundering Act of 2020 (AMLA) have included cryptocurrencies, exchanges, and custodian wallet providers under their scope.
This means that the covered entities are required to implement necessary measures like KYC to detect and protect against suspicious activity. This is to prevent financial crime and other fraudulent operations from transpiring through the network. Still, compliance with know-your-customer (KYC), anti-money laundering (AML), and countering the financing of terrorism (CFT) regulations is ridden with challenges, especially when crypto exchanges and digital wallets rely on legacy identity verification systems.
Pitfalls of Traditional KYC in the Crypto Industry
KYC means identifying and verifying the customer’s claimed identity. The typical KYC process requires any of the following personal information:
- Full name
- Date of birth
- Social security number (SSN)
- Complete address
A photo of the user’s valid government-issued ID (e.g., a driver’s license, state ID card, or passport) is also requested. In some instances, they may be asked to present additional verification, such as a utility bill to confirm their address. Since crypto exchanges often rely on third-party providers to do the verification process, the completion time varies from minutes to several business days.
The premise of traditional KYC is that by comparing the customer’s personal information to the data in the government ID, the institution can confirm that the person creating an account is the true identity owner. However, the requirements used in this method can be easily obtained from someone else or falsified by a criminal.
Traditional KYC is no longer an effective means of identity verification in the digital world, and relying on it puts one’s financial health at risk. Apart from its susceptibility to criminal attacks, conventional KYC procedures are quite costly to implement and cause friction during onboarding. Not only is it a hassle for the institution but for customers as well.
For crypto enterprises to eliminate the issues associated with traditional KYC, they need to replace it with its electronic counterpart or eKYC.
What eKYC does for Crypto
Electronic KYC, or eKYC, automates and streamlines the entire identity proofing process. It harnesses digital identity verification solutions that are straightforward, quick, and cost-effective.
During onboarding, the user will undergo biometric identity verification by taking a quick selfie and uploading the identification documents with the enterprise’s eKYC portal. They will also be asked to complete an active liveness confirmation to prove their real-time presence at the point of enrollment.
With eKYC, crypto exchanges and custodian wallet services can enjoy the following advantages:
- Reduced Financial Crime Risks Through robust eKYC, the customer’s identity documents will be screened against government registries, global watchlists, and other trusted databases to determine their propensity for criminal behavior. If the automated system finds a match to an existing offender or reveals that the ID is fake, the user will not be verified, stopping the onboarding process. This prevents criminals from getting into the system right from the start. It also ensures that crypto service providers only enroll legitimate customers.
- Stringent Compliance with Relevant Regulations Crypto exchanges and custodian wallet services are subject to hefty fines and other penalties for non-compliance to KYC and AML/CFT regulations. In the US, the Financial Crimes Enforcement Network (FinCEN) fined a virtual currency derivatives exchange $100 million for deliberate violations of the BSA in 2021. The parties involved were each charged with one count of violating the BSA and one count of conspiring to contravene it. Each offense entails a maximum prison sentence of five years.
Meanwhile, in the EU, non-compliant crypto service providers can face up to €200,000 worth of fines. The EU is already expanding its regulations through the sixth Anti-Money Laundering Directive (6AMLD).
- Improved Trust Among the Stakeholders Adopting digital identity verification measures as part of eKYC fosters trust between the institution and the customer.
Besides giving crypto service providers a high level of certainty on who uses their platforms, eKYC also lets customers know that the company is taking the necessary steps to ensure robust protection against criminal attacks.
It gives customers the confidence that their valuable data and assets are safe, which is critical, especially for peer-to-peer crypto platforms where scams are rampant. They can rest assured that bad actors are kept away from the network, and the person they are transacting with is a legitimate one.
The increased trust and use of crypto services can also help stabilize the crypto market and open the door to its wider adoption.
- Minimized Friction and Enhanced Customer Experience Unlike traditional KYC, the eKYC system is fully automated, eliminating friction and allowing the entire procedure to be completed in a few seconds. Additionally, since most mobile devices already have built-in hardware to support fingerprint and facial scans, it makes the process more convenient and hassle-free.
Striking a balance between security and seamless user experience is challenging for many enterprises. But with biometric identity verification, crypto exchanges and wallets can provide both to consumers.
The sensitive data collected by crypto enterprises and the value of money involved make crypto enticing for criminals. If crypto service providers want to implement eKYC, they will need the right solutions for their system.
LoginID is an API-based FIDO-certified passwordless authentication and transaction confirmation with biometric digital signature provider. Its solutions are highly secure, simple to integrate, and reduce onboarding friction. Get started by getting in touch with our experts today at sales@loginid.io. Or you may also register an account to get immediate access to LoginID’s authentication solution for free.
Check out our tutorial or our documentation for more information.
**References: ** https://www.cognyte.com/blog/cryptocurrency-crime/https://www.fool.com/the-ascent/cryptocurrency/articles/what-is-kyc-and-why-do-crypto-exchanges-require-it/https://www.bloomberg.com/news/articles/2021-04-06/former-bitmex-ceo-arthur-hayes-surrenders-to-face-u-s-charges
