Crypto KYC: New School Meets Old School Compliance

August 29, 2023
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Understanding the evolving aspects of crypto KYC in the digital asset industry

In the evolving realm of cryptocurrencies, such as Bitcoin and Ethereum, the traditional concept of Know Your Customer (KYC) is experiencing a profound transformation. While KYC has long been a cornerstone of compliance in the financial sector, its importance is being redefined with the advent of digital assets, innovative crypto-based financial products, services, and the tech-savvy expectations of its burgeoning customer base. Many historical regulatory expectations and compliance best practices of KYC remain consistent and agnostic to technology. However, there are nuances that are uniquely tied, or more common to the world of digital assets.


For a concise overview of KYC basics, watch our two minute video that delves into the pivotal roles of KYC and Customer Due Diligence (CDD).

The Distinctive Aspects of KYC in Crypto Industry

One of the standout features of KYC in the crypto realm is the significance of the wallet address. Unlike conventional financial systems, where the identity of an individual is tied primarily to their personal details, the crypto space introduces the wallet address as a pivotal identifier.

Wallet Addresses and Their Revelations:

In the decentralized world of crypto, a wallet address doesn’t just signify an origin and destination for a transaction. Rather, it enables compliance professionals (and the public) to research the entire prehistory of the address, including past transactions and counterparties to those transactions. Not to mention, trace the movement of funds in future transactions sent from the wallet address. 

The transaction history of the wallet address, while pseudonymous, can help us learn more about the customer and their financial dealings. This includes transaction volume, transaction velocity, transaction amounts (individual and aggregate), the movement of funds, and other pieces of valuable information, all of which are available for public inspection on the blockchain. In the world of traditional banking, this is not possible. 

By comparison, the transaction records of a customer at Bank X cannot be publicly viewed by Bank Y. There are proper channels for banks to share information in certain circumstances (e.g., 314b), but not to the extent of blockchain records, and certainly not publicly.

While transaction volume, velocity, amount, and other on-chain data, are largely dependent upon more traditional KYC information on file about the customer (e.g., source of funds, occupation), there are some rules-based alerts associated with wallet addresses that speak for themselves

Shared Wallet Addresses:

Multiple individuals sharing the same wallet address is a known and now established red flag in the crypto space (and one we might add examiners are on the lookout for).  While individuals may use more than one wallet address, the sharing of an address signifies multiple individuals working in concert. They may be doing so to avoid disclosing the customer information of one or more parties, or it could be a wallet address maintained by a scammer who is receiving funds from several unsuspecting victims.

OFAC SDN and Wallet Addresses:

The inclusion of wallet addresses in the Office of Foreign Assets Control (OFAC) “Specially Designated Nationals” (SDN) list is another critical development. Previously, the SDN list mainly included individuals, entities, and associated information such as date of birth or country. Now, with the inclusion of wallet addresses, the scope of customer screening has expanded. It’s not enough to screen customer names and other traditional KYC attributes, financial institutions must also screen sender and receiver wallet addresses by, to, from, or through their platform. 

IP and Geolocation in Crypto KYC:

The very nature of cryptocurrency transactions, which can be initiated from virtually anywhere in the world, has underscored the importance of IP and geolocation screening, as well as regulatory restrictions based on location. This is essential, not just for the purposes of KYC, but also to prevent potential sanctions violations and transacting from within a jurisdiction where the crypto institution is not licensed or otherwise authorized by regulators to provide its products/services.

As transactions in the crypto space are inherently remote and borderless, comprehensive IP and geolocation screening becomes paramount to ensure that the participants and the transaction itself are compliant with regulatory standards. Although not exclusive to crypto financial services, geofencing and IP controls are of critical importance in the borderless world of digital assets. 

Related: Common Ways Your Customers May Try To Avoid KYC

Ensuring Authenticity with Liveness Detection

Liveness detection, a software solution to detect if a person’s face (or other biometrics) is real, has emerged as a cornerstone in modern KYC practices within the realm of cryptocurrency. This advanced technology seeks to provide real-time evidence of a user’s physical presence during the identity verification process. By doing so, it aims to ensure that every transaction, every access point, is backed by a genuine person, and not by some form of replicated identity or digital bot.

The core purpose of liveness detection is to thwart attempts at fraudulent identity verification. In a digital age rife with sophisticated scams and hacks, this mechanism acts as a frontline defense, ensuring the integrity of each participant in a transaction. However, as artificial intelligence continues to evolve, so do the challenges. Rapid advancements in AI mean that the technology itself might be manipulated or tricked into false validations.

But it’s not all challenges; there are some silver linings. The sophistication of liveness detection technology, combined with its integration into KYC processes (new school and old school), provides organizations with a more refined toolset for customer engagement. It not only helps safeguard against fraud but also offers insights into genuine customer behavior.

Blockchain Analytics – Decoding Transaction Patterns

Blockchain analytics plays a pivotal role in augmenting the scope of KYC within the cryptocurrency space. At its core, while a basic wallet address provides rudimentary details about transactions, as previously discussed, it’s through blockchain analytics that we can truly unravel the intricate web of transactional activities. This powerful tool offers a comprehensive understanding, shedding light on transaction patterns, pinpointing origins, and tracing destinations, thus allowing a more nuanced analysis of customer and transaction risk.

Further enriching the analytics are proprietary scoring methodologies, specifically designed to gauge the risk levels linked with particular wallets addresses and transactions. These scoring mechanisms act as a compass for institutions, guiding them through the vast and complex world of blockchain data. They help in discerning which transactions might pose higher risks, ensuring that the entities involved remain vigilant and proactive in safeguarding their digital operations.

In Conclusion

Cryptocurrencies offer unprecedented advantages—borderless transactions, financial inclusion, and decentralized frameworks. However, these attributes have raised concerns about illicit activities. The response has been the adoption of KYC measures tailored to the digital asset domain, not as a substitute for traditional KYC measures, but rather as a compliment to them. Those offering cryptocurrency financial services must region-ize and maximize the utility of both. While new and crypto-focused KYC tools are powerful countermeasures, they are often weakened and in some cases even useless without incorporating more traditional or historically tried-and-true aspects of KYC.  

If you’re engaged in a cryptocurrency project, BitAML offers the expertise and guidance required to navigate the intricate realm of compliance from KYC and beyond. With a profound grasp of various cryptocurrency systems, our team is equipped to assist you in staying proactive and compliant. Reach out to us today to explore how BitAML can bolster your compliance initiatives in the ever-evolving cryptocurrency landscape. Experience how BitAML streamlines KYC practices for the future of blockchain.

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