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Why is KYC Important on a Crypto Exchange?

Cryptocurrency was created as an avenue to give users control over their funds. The clamor for a new financial system grew following the 2008 financial crisis which saw innocent investors lose their funds. The goal of bitcoin, the first-ever cryptocurrency then was to help users store value outside of legacy institutions.

While cryptocurrencies utilize blockchain technology for financial transactions, they also protect users’ identities by replacing personal information with strings of alphanumeric characters. This ensures that individual identities stay anonymous while the blockchain itself stays decentralized.

However, it did not take long for criminals and fraudsters to capitalize on the attributes of blockchain technology in perpetrating their heinous acts. KYC has been introduced to help curb these illegal movements of funds. Hence, it has become an essential component of most crypto exchanges.

What is KYC?

KYC means “Know Your Customer”. It is a mandatory requirement that all crypto users must pass through if they wish to use the services of centralized crypto exchanges. In a KYC process, a customer must provide certain information about their identity in order to be able to use the exchange. The more information they provide, the more features they will have access to on the platform.

The KYC procedure is necessary because it helps crypto exchanges to operate within the framework of jurisdictional regulations in the country where they operate. It also helps exchanges track and prevent suspicious activities that might be linked to money laundering, theft, and terrorism financing. Hence, KYC is a means to create trust between the crypto exchange and its customers.

Why KYC is important on a Crypto Exchange

It must be mentioned that not all crypto exchanges require KYC. The process is quite common among centralized exchanges due to their custodial capabilities. On the other hand, most decentralized exchanges do not require KYC because they are non-custodial. Users only need to connect their crypto wallets whenever they wish to conduct transactions on a decentralized exchange.

Having explained this, below are some of the reasons why KYCs are important on a crypto exchange;

KYC helps to establish trust between a crypto exchange and a user. This is made evident in the verification tiers that users attain at each stage of their KYC process. The more information a user provides, the more functions they can access on an exchange. This shows that an exchange has verified the status of a user and is willing to grant them access to its full products and features.

It is true that blockchain allows decentralization and anonymity in transaction execution. KYC does not change this fact. KYC only helps centralized crypto exchanges to stay compliant with jurisdictional regulations in the countries where they operate. Usually, these exchanges do not reveal user data to governments, but they need to know their users’ identities in the event of fraud and other illegal activities.

From time to time, criminal elements try to use crypto exchanges to launder money. They do this to avoid the radars of governments and anti-money laundering agencies. Crypto becomes an option for criminals because of its decentralization and anonymity. With KYC and AML systems in place, it becomes hard for criminals to redirect funds and launder through cryptocurrency. This also helps exchanges stay on the good books of regulations.

KYC also helps to prevent terror financing. Terrorism is already a major cause for concern for governments around the world and governments have set up measures to prevent terror financing in the traditional finance system. The borderless nature of cryptocurrencies, therefore, creates an avenue for terrorists and their sympathizers to exploit. Through KYC, such acts are swiftly detected and the flow of funds to terrorist networks is prevented in due time.

Conclusion

KYC is an important measure in the crypto space. Despite its obvious challenge of undermining user privacy, it is a vital element for preventing fraud and money laundering through cryptocurrencies.

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