Educational Byte: What is KYC and How Does It Relate to Cryptocurrencies?

Know Your Customer or Client (KYC) is a process you've probably already gone through without even thinking it had a specific name. Basically, it’s the set of techniques used by businesses to verify the identity of their customers. It ensures that the person using a service is who they claim to be, reducing risks like fraud, money laundering, and illegal activities.

KYC is particularly important in industries like banking and finance, where trust and security are essential. By collecting and verifying customer information, companies can comply with legal regulations and maintain a safe environment for their services. KYC methods typically involve collecting personal information such as a customer’s name, date of birth, address, and government-issued identification (e.g., passport or driver’s license).

Many companies use online verification systems where customers upload photos of their ID and a selfie for comparison. Others may request physical copies or in-person verification. Advanced methods like biometric scans and AI-based tools are also becoming common to streamline the process and enhance security.

In other words, KYC is the way regulations reach the common financial user, who must identify themselves in order to use these services. And yes, it could apply to cryptocurrencies, depending on what you’re doing.

Why KYC at All?

The short answer to his question is that people launder money and commit other financial crimes all the time. The United Nations Office on Drugs and Crime estimates that globally, between 2% and 5% of GDP is laundered annually, amounting to approximately €715 billion to €1.87 trillion. By verifying customer identities, financial institutions can detect and deter illicit activities, ensuring the integrity of the financial system. Implementing KYC procedures helps mitigate these substantial risks.

‘Helps mitigate’ is a key part here, though. KYC is a technique among others, and it’s not perfect. These regulations are enforced worldwide, with each country tailoring its approach to meet international standards set by organizations like the Financial Action Task Force (FATF). However, criminals continuously adapt to the rules and find ways to bend them. They use advanced methods like creating complex networks of shell companies or falsifying documents to obscure their dubious transactions.

Other KYC Issues

Besides the above, not all countries enforce KYC and anti-money laundering (AML) regulations equally, and even in countries with strict KYC laws, enforcement can be inconsistent. The sheer scale of global financial transactions makes it challenging for KYC systems to catch every suspicious activity. Financial institutions process billions of transactions daily, and even with automation, some illegal activities could slip through.

Now, try to imagine the illegal percentage without KYC. That’s why we have to identify ourselves to use financial services. However, this identification process can be a burden for people who aren’t committing crimes, and not only because they have to show their IDs: it’s because of how their IDs and personal data are stored and used by companies.

They could misuse or sell this data to third parties for different purposes, including aggressive marketing that nobody asked for. Not to mention that hackers could breach their systems, steal everything, and re-sell it on the Darknet. The larger the company, the larger the prize to hackers. We could say KYC is a necessary evil, but decentralizing our information and funds seems to be a better option.

KYC in the Crypto World

You could be thinking that the point of crypto is kind of to be anonymous, or at least, more private and without limiting requirements. Cryptocurrency was created to be inclusive and free. Free from governments, free from banks, free from red tape. It still could be (free from most old things), but centralized companies aren’t the same. They must comply with regulations to keep operating, and that includes KYC. So, naturally, companies like crypto exchanges, crypto funds, crypto investment intermediaries, custodial wallets, and so on, will apply KYC in most cases.

When you sign up for a regulated crypto exchange, for example, they might ask for your name, address, and a copy of your ID—just like a bank would. This, of course, eliminates some of the freedom that crypto provides, so the crypto community has mixed feelings about KYC. On one hand, it builds trust and opens doors for broader adoption by aligning with government regulations.

On the other hand, it challenges the privacy-focused nature of the crypto world. Despite the debate, most major exchanges, like Binance and Coinbase, have embraced KYC to stay compliant, and if you want to use their services, you’ll have to identify yourself. Now, there’s still a way to avoid KYC: transact in a fully peer-to-peer (P2P) manner, without intermediaries.

That could be risky, though. The other party involved could scam you, so that’s why we often prefer regulated intermediaries. In Obyte, we’re aiming to erase intermediaries and go fully decentralized, so we developed conditional payments. These payments rely on smart contracts (and an arbiter, optionally) that lock funds until agreed conditions are met. For instance, you exchange tokens only when both parties fulfill their parts of the deal, ensuring security and trust without needing middlemen or complex verification processes.

Ready to try it? Conditional payments and contracts with arbitration are built-in in the Obyte wallet, which is available to everyone!

Featured Vector Image by redgreystock/Freepik