Because crypto is becoming more integrated with the traditional financial system, know-your-customer (KYC) requirements are now an increasingly important part of Web3.
Among the most important steps to take in order to prevent money laundering is to ensure that you have a proper crypto KYC process in place. A KYC process is a process of verifying who your customers are and what type of activity they may be engaging in. In addition, a KYC process will also ensure that you are able to detect suspicious activity.
KYC checks are an important component of the global financial system’s infrastructure, allowing cryptocurrency businesses to comply with anti-money laundering (AML) regulations.
Know Your Customer (KYC)
Even if you don’t operate a crypto exchange or other financial services, Know Your Customer (KYC) is important for preventing money laundering and it is something every investor should look for. The process helps you identify suspicious activity, monitor accounts and detect money mules.
Money launderers move money through hundreds of wallets and into different financial institutions. They also seek to exploit vulnerabilities in cryptocurrency transactions by engaging with third parties. These types of transactions can move money between accounts in seconds. These activities can also lead to heavy penalties.
Federal law requires financial institutions to verify their customers’ identities and report suspicious activities. In the past ten years, banks and other financial institutions have paid a total of USD 26 billion in fines. Of course, the reverse would have been nice so that investors would be able to check the veracity of an exchange. FTX, anyone?
Crypto exchanges have faced the same issues. As cryptocurrencies have grown in popularity, regulators have become more concerned about the potential for money laundering. They are putting more stringent regulations in place to prevent money laundering.
Crypto exchanges must perform KYC checks to ensure that they are complying with the law. These checks include examining customer identifying information and screening customers for international sanctions. Crypto exchanges should also share this information with other financial service providers.
A risk-based approach to KYC compliance allows crypto exchanges to create detailed risk profiles for customers. These profiles help them assess individual risks and adjust AML/CFT controls to accommodate them. Using a risk-based approach, exchanges can also better deploy their resources, improving the customer journey, and protecting customers from negative experiences.
Crypto exchanges must implement robust KYC processes in order to prevent money laundering and other crimes. Using an effective KYC process can help businesses avoid costly penalties and expedite transactions.
The best practices for KYC include using a risk-based approach to compliance and assessing risk on a customer-by-customer basis. The use of software solutions that automate KYC procedures can help exchanges develop richer risk profiles for their customers.
Automated KYC processes
Keeping up with the constantly changing regulatory environment is one of the biggest challenges faced by crypto exchanges. As regulations grow globally, crypto firms need to implement the right technologies and policies to stay compliant. Fortunately, there are a variety of KYC solutions available to crypto firms that can help. And now in the post-FTX world government regulation is most likely a fait accompli.
These solutions use a variety of methods to collect and verify customer data. AI-powered verification solutions, for example, use smart algorithms to ensure that the data provided is accurate and legitimate.
Crypto exchanges need to implement a robust KYC procedure to ensure that their clients are not subject to undue financial risk. In addition, they must monitor transactions for suspicious activities. They must also prevent the opening of multiple accounts and identify money mules.
These procedures can also improve the security of trading platforms and reduce the risk of money laundering. Crypto firms can also use these processes to better monitor the activity of their clients and protect them from fraudulent addresses.
As crypto exchanges are subject to Anti-Money Laundering (AML) regulations, it is important to implement a suitable KYC procedure. Having a system in place that automates the process can help exchanges remain agile in a rapidly changing regulatory environment.
These systems can also help crypto firms build richer risk profiles for their customers. This information helps financial service providers identify clients who are abusing their services. They can also use the data to combat terrorism financing.
These systems can also reduce the risk of regulatory penalties and legal disputes. They also can help ensure that exchanges remain compliant with international guidelines and rules. Lastly, they can help exchanges make risk-based decisions quickly.
KYC and taxes
Almost any cryptocurrency transaction must be reported to the IRS. Failure to report can result in a tax audit and a possible criminal referral. Attempts to hide transactions or evade detection will also result in a tax evasion charge. The IRS will be on the lookout for potential abusive activities, so crypto exchanges need to be careful to avoid becoming targets.
The IRS has issued warnings, but it is not clear whether these are an indication of an impending enforcement effort. In the past, the IRS has issued guidance regarding the tax treatment of virtual currency transactions. However, recent shifts in the IRS’s focus from guidance to warnings may indicate the IRS’s intent to prosecute taxpayers who fail to report their cryptocurrency transactions.
In addition to the IRS, the Department of Justice has also been working on crypto-related investigations. The DOJ has targeted institutions involved in money laundering and tax evasion. These investigations include the Swiss Banks Program, a major case against a financial institution.
The DOJ has also announced the formation of a national crypto enforcement team. The team will combine the expertise of the criminal division and other sections of the Department to address fraud and other financial crimes involving crypto. The team will target virtual currency exchanges and other actors involved in money laundering.
The AML Act amended SS 1956 to make it a crime to conduct a financial transaction with the proceeds of a prohibited activity. However, the government does not need to prove that an individual has actual knowledge of the transaction. Instead, it is necessary to prove that an individual or organization engaged in the transaction knowingly and deliberately attempted to avoid paying tax.
KYC: detecting suspicious activity
Detecting suspicious activity on cryptocurrency exchanges requires the combining of expertise in cybersecurity and transaction monitoring. Suspicious activity may include illegal activities such as P2P marketplaces, gambling sites, and darknet marketplaces. The transactions may also originate from high-risk jurisdictions. These may include the U.S. or countries with poor anti-money laundering regulations.
Money launderers use the online trade of virtual assets to avoid AML/CFT checks. They exploit the speed of the exchanges to convert illegal funds into cryptocurrencies. These funds may then be sent to a different country or exchange. The funds may then be transferred to another currency or to a customer.
Detecting suspicious activity on cryptocurrency exchanges is becoming increasingly important. FinCEN expects exchanges to report all suspicious activity. However, financial institutions may delay reporting for 30 calendar days to identify the suspect.
The FinCEN advisory noted the potential for increased ransomware attacks. It also identified financial institutions’ obligation to file suspicious activity reports. It suggested that exchanges should invest in technologies that explore the transaction history and identify financial infrastructure that supports ransomware. The government is implementing a sophisticated approach to identifying suspicious patterns and tactics.
Crypto exchanges need to proactively identify ransom payments. They should also develop policies regarding ransom payments. Exchanges should also implement account-level transaction monitoring capabilities. They should train their AML program staff to handle ransomware cases. They should also maintain a dedicated unit to manage ransomware alerts.
Final thoughts
Detecting suspicious activity on cryptocurrency exchanges requires the combining of expertise in cybersecurity, transaction monitoring, and law enforcement. These services are designed to detect suspicious transactions, identify customers with political exposure, and screen customers against relevant international sanctions lists. And lest we forget that despite all the negative press crypto receives (much of it deserved-especially recently) it is fiat currency that is the prize hackers and fraudsters seek most often.
In the wake of the FTX meltdown it is crucial, now more than ever, for both investors and exchanges to be vigilant.
Jay Speakman is a technology writer based in San Francisco, California. He writes on the topics of blockchain, cryptocurrency, DeFi and other disruptive technologies. Clients include Avalanche, Be[in]Crypto, Trust Machines and several blogs devoted to blockchain gaming. He will not rest until fiat currency is defeated.
