Cryptocurrency exchanges are magnets for fraudsters – and regulators.
Let’s learn how to beat the former and appease the latter with better crypto KYC and identity verification tools.
What Is KYC in Crypto?
Crypto KYC, or Know Your Customer, is a legal requirement for centralized exchanges to verify their users’ identities. It is designed to ensure that their users do not use crypto launder money, dodge income tax, or finance illegal activities.
With their inherent relationship with money and pseudonymous digital assets, crypto exchanges are particularly targeted by fraudsters and criminals, which is why governments have imposed growing KYC and identity verification regulations in recent years. However, KYC is still seen as an unwelcome obstacle by crypto exchanges and crypto enthusiasts. A 2019 report by the regtech Coinfirm claimed that 69% of crypto businesses did not have “complete and transparent” KYC procedures.
How Does KYC Work With Crypto?
KYC checks are similar in crypto to the process for traditional financial institutions. The rules are set by government regulators and must be adhered to depending on the crypto exchange’s geographical location.
In concrete terms, the cryptocurrency KYC process will need to verify the user’s:
- full name
- residential address
- date of birth
- ID document confirming the above
These checks can be performed manually, but are more likely to be automated via KYC software, which can offer a risk-based approach as well as identity verification tools.
Since crypto exchanges are also mandated to follow anti-money laundering regulations, it is also beneficial to combine KYC and AML checks, which include PEP checks, sanction checks, and adverse media checks.
Note that some crypto exchanges are also required to monitor users on an ongoing basis, for instance by using transaction monitoring.
The Benefits of Using KYC in Crypto
Using some type of KYC step at onboarding is very beneficial for crypto exchanges and platforms, for several reasons. Let’s take a closer look:
- Boosts compliance: In several locales, KYC is a legal requirement in crypto and fintech. Not doing your KYC due diligence can result in fines or even licensing issues linked with AML and CFT legislation.
- Reduces fraud: Implementing know your customer protocols prevents fraud of all types, as you learn more about your customers and can monitor (or outright block) anyone who appears to be high-risk.
- Increases trust: By implementing robust KYC, you can increase consumer trust, as you demonstrate to your customers that you take their business seriously and follow the word of the law.
- Protects the ecosystem: KYC is a step to help protect the financial ecosystem, preventing money laundering, terrorism financing, and other fraud.
- Protects your reputation: Your crypto platform’s reputation is similarly boosted and protected as you can demonstrate the solid steps you’ve taken to protect customers’ assets and accounts.
- Promotes the crypto vision: Customers who may have felt hesitant to invest in crypto are more likely to engage once they trust they are in legitimate, safe hands. This way, everyone wins.
The Challenges of KYC in Crypto
Even with the best of intentions, crypto exchanges face an uphill battle when it comes to KYC.
Here are four reasons why:
- A plethora of fake ID types: Fraudsters are aware of KYC procedures and have plenty of weapons at their disposal. From synthetic IDs to deepfake videos, it’s easier than you might think to be accepted on a crypto exchange using a fake profile.
- The need to balance friction and security: Users want quick access to the markets – especially when they’re as volatile as crypto. So if you put too many obstacles in the way at the onboarding stage, you risk increasing churn and losing potential loyal customers in the long run.
- Going against crypto ideals: Enthusiasts often regard crypto as an innovative technology that shouldn’t be subjected to the same rules as traditional financial institutions. Unfortunately, regulators see it differently, which is why you, as a crypto exchange, might have to sweeten the deal when asking users to submit official documents. Many crypto exchanges, for instance, offer special deals for users who complete the KYC verification process.
- Last but not least are compliance fines. Fail to deploy the right KYC checks and you could be on the hook for a hefty fine.
It’s not just crypto exchanges that are under growing scrutiny from regulators either, but many more crypto-related companies. In 2020, for instance, a crypto tumbler was fined $60M for failing to meet AML requirements.
A reward offered by a crypto exchange for completing the KYC process.
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Best Tools and Features For Crypto KYC
Cypto exchanges rarely perform KYC checks manually, which is why their KYC software should offer the following tools and features:
1. ID Selfie and Video Verification
A new generation of identity verification software vendors makes it easy to integrate document verification for your KYC crypto checks.
However, it should be noted that these tools adds a ton of friction to the customer journey. There is also the issue of falsification, as fraudsters can photoshop IDs or even upload stolen IDs.
Last but not least, these checks are expensive. Each automated document check is estimated to cost $2 on average.
2. Digital Footprint Analysis
Digital footprint analysis can be either used as a pre-KYC check or as an additional layer of security for your crypto KYC process.It allows companies to learn more about users based on hidden digital and social signals.
It works by gathering data around things like an email address, IP address, phone number, or the kind of browser and device used to connect to a site.
- IP Lookup: By running an IP data enrichment check, you can find high-risk information such as harmful IPs, suspicious datacenters or VPNs.
- Email and phone Lookup: lets you flag free email providers or virtual SIM cards, among others.
- BIN Lookup: identifies the card issuing bank or invalid details, which is helpful to create a profile of your customer.
Armed with all the information above, we can now get a better picture of who we’re dealing with, especially as the data is fed through risk rules, which help calculate how risky the user is during the crypto KYC stage.
3. Device Fingerprinting
Crypto users’ devices contain hundreds of datapoints that can be used to profile them at the KYC stage. Their combination of software and hardware is likely to be unique, which can become a key identifier – especially if you’re trying to find connections between accounts.
The same technology is also helpful in weeding out bad agents who obviously rely on emulators and virtual machines to access your crypto exchange. Since these are considered high risk, you should not even proceed with a full KYC check.
4. Blockchain ID Validation
Finally, a fairly new proposition in the world of ID verification is using the power of blockchain technology. There are certainly a number of advantages – in theory at least. Since blockchain tech is at the core of the Web 3.0 ecosystem, it might be an attractive solution for crypto enthusiasts who value their anonymity.
Blockchain IDs have also been shown to deliver excellent results in terms of affordability and efficiency. A study by Finextra, for instance, revealed that HSBC experimented with KYC blockchain successfully in the UAE in 2021.
Blockchain KYC is still new, though – which is one of its major drawbacks. Until the technology is adopted by the masses, you may struggle to find one good service that has enough ID data to validate users from around the world.
And, no matter whether this method works, authorities need to explicitly allow this type of KYC in your locale for you to use it to fulfill your legal obligations.
How Does Digital Footprint Analysis Help KYC in Crypto?
SEON has proven results with crypto exchanges in helping KYC checks and reducing chargebacks due to bad credit card purchases. But when it comes to ID verification, here’s why it works:
- It removes all kinds of friction: It’s all real-time data, which you can gather via API.
- It saves you money: Crucially, it is a pre-filter to block junk users before performing expensive KYC checks. This means you don’t have to waste your money vetting obvious fraudsters.
- It gives you extra intelligence: You can use it to augment your KYC or AML during manual reviews. For instance, even if a user passes the ID verification check, you could still increase your suspicions should they have no social media profiles or hide their connection behind a VPN and emulator – and monitor them more closely.
And that’s before we even mention the flexible 30-day SEON trial and cancel-anytime contracts, designed to let you fight ID fraud however you see fit.
You can give this a try below. Just enter someone’s email address or phone number and you’ll discover their digital footprint and how much it can tell us about whether they are a legitimate customer.
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Frequently Asked Questions
Crypto exchanges have to verify IDs and perform KYC checks as a legal requirement. They face hefty fines from authorities if they don’t, regardless of where they are based.
IDV verification in cryptocurrency is the process by which crypto exchanges check the official ID documents and proof of address of new customers in order to be certain that these individuals are who they say they are. IDV is one of the main KYC requirements in cryptocurrency.
This can involve asking them to upload scans of their passports or driver’s licenses, for example, or to join a video chat with an agent who will ask them to speak their name and show these documents to the camera.
No, crypto wallets do not need to conduct KYC on their customers. However, crypto exchanges who also provide wallets will need to do KYC, unless they keep the two products entirely separate. What’s more, certain wallet operators may choose to do KYC proactively. As a consumer, you can choose to use a crypto wallet that does not require KYC compliance, or one that does.
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Bence Jendruszák is the Chief Operating Officer and co-founder of SEON. Thanks to his leadership, the company received the biggest Series A in Hungarian history in 2021. Bence is passionate about cybersecurity and its overlap with business success. You can find him leading webinars with industry leaders on topics such as iGaming fraud, identity proofing or machine learning (when he’s not brewing questionable coffee for his colleagues).
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