What is KYC/AML and Why does it matter for the Crypto Industry?

by | Jul 12, 2018

As cryptocurrency markets grow and attract more institutional investors, it’s becoming clear that some best practices from the banking sector will be adopted in the crypto space. Some of these regulations are simply necessary for investors to meet for compliance purposes, and others have understandably evolved over the development of traditional markets to meet the needs of investor security.  Today, it is important that companies involved in cryptocurrency who cater to these investors understand how these practices and regulations can affect multi-asset trading. One set of practices that’s become especially prominent in recent years is KYC/AML controls: Know-Your-Customer, and Anti-Money Laundering.

These terms are often conflated, but AML is a much broader concept. AML practices began in response to laws such as the Bank Secrecy Act of 1970 (USA), which required financial institutions to cooperate with regulatory authorities to detect money laundering and other illegal activities. These regulations – in the US and elsewhere – were strengthened piecemeal over the years, and an intergovernmental task force was formed in 1989 by governments of the G7 countries. After the September 11, 2001 attacks, AML regulations took on additional provisions to counter the financing of terrorism (CFT, or CTF). AML regulations are important for both law enforcement and also for financial institutions themselves who want no part in aiding or abetting criminal activity.

KYC is a set of processes within the framework of AML controls specifically to verify customers’ identity. In cases where a corporate body owns an account, for example, the purpose is to identify the ultimate beneficiary of a transaction. Aside from regulatory compliance, KYC procedures help ensure the safety of customers’ assets through transparency and establish a financial institution’s credibility for dealing with other entities.


KYC/AML Procedures and Technology

Traditional KYC/AML processes that are in use by most banking institutions are quite simple. They often involve scanning or copying documents, checking information against a database, and other manual processes. These processes are thorough, and the cost of compliance for today’s financial institutions is estimated in the billions of dollars.

Additionally, some start-up financial services companies are developing new, more customer-friendly KYC processes that can be as simple as taking a “selfie” with an identity document. There are even new KYC/AML solutions that use a customer’s social media to verify identity. Given the tremendous costs involved, a whole industry of third-party KYC/AML providers has emerged, though it is unclear to what extent financial institutions can outsource their KYC/AML processes.

Further, there is increasing usage of electronic verification techniques that are compliant with AML regulations. For example, Belgium’s leading banks have introduced “itsme,” an AML-compliant electronic ID (“eID”) that can be used to open a bank account, make purchases, sign up for a mobile phone plan, or even file a tax return. Other European countries have similar eID’s, including Sweden (BankID), Spain (DNIe), and Estonia (ESTeID). Estonia has also recently introduced legislation specifically relating to cryptocurrency regulation and AML compliance.

More experimentally, there have been some attempts at using blockchain technology itself to identify individuals. Much in the same way that a national or industry database would be used today, this technology seeks to use the blockchain to record everything from personal information to property ownership, marriage records, and more outside of any national government. Just as cryptocurrencies use blockchains to identify ownership, the blockchain could also be used to identify owners themselves for KYC compliance. However, this technology is still quite far from being accepted by any current regulatory bodies for use in banking practices.


KYC/AML Enforcement For Cryptocurrencies

For now, the bottom line is that every financial entity from too-big-to-fail banking behemoths to the latest ICO offerings are under intense scrutiny for KYC/AML compliance. There are an increasing variety of solutions to the problem, but the methodology behind all of them are the same: know who your customer is! In the past few years, HSBC, Standard Chartered, Wachovia, Deutsche Bank, Commonwealth Bank, and other institutions have been fined billions by regulators in the US, EU, and Australia for failure to sufficient AML controls. In short, this compliance matters.

Regulatory authorities are now taking a closer look at cryptocurrencies in particular because many people still see crypto principally as a means for money laundering and other criminal financial activities to take place outside of the traditional banking system. American regulators have even threatened to prosecute those involved in new ICOs which do not comply with KYC/AML regulations.

Aside from eager regulators taking an increasingly close look at the cryptocurrency space, the team at Vault views compliance with KYC/AML regulations as imperative for yet another reason: USDVault is unique among cryptocurrencies in that it is both pegged to the dollar and can be redeemed for physical gold.

The precious metals industry has a decades-long track record of compliance with AML processes because gold was (and still is) often used for money-laundering purposes; the yellow metal has many of the same properties that make cryptocurrencies attractive for unsavory financial transactions. Any customer or institution engaging with Vault and its fiduciaries will need to pass KYC/AML compliance upon issuance and redemption of USDVault tokens. This added layer of security will be a mostly painless process for users but gives USDVault increased credibility as a stablecoin. In Vault’s quest to reduce investor risk in the cryptocurrency marketplace, KYC/AML controls are just one of the many practices Vault is implementing to ensure safety and stability for cryptocurrency investors.