Are Crypto Exchanges Serious About KYC, AML and CFT Compliance?
Crypto exchanges are an integral component in the cryptocurrency ecosystem and have been identified as one of the areas that need tightened regulatory oversight.
It is this aspect that has seen regulators focus on exchanges and push them to have robust Know-Your-Customer (KYC), Anti-Money Laundering (AML), and Combating the Financing of Terrorism (CFT) checks and procedures.
The goal is to ensure exchanges are not used to undertake illicit transactions. It is also all about improving user experiences by increasing account or wallet security, hence the push for compliance.
Across the world, a select number of exchanges have taken the issue of compliance seriously, as recently noted after the May 7 hack of Binance. The platform carried out a security upgrade, with the CEO Changpeng Zhao saying that new measures would include an improvement to the exchange’s risk management and in KYC.
What are KYC, AML, and CFT?
Most of the major crypto exchanges have measures regarding KYC, AML and CFT compliance. However, the adherent isn’t the same and application depends on the country of jurisdiction.
Know Your Customer, or KYC involves the procedures and mechanisms a financial institution employs as a way of identifying its customer.
The process may vary, as noted, but basically would see a company verify customer’s identity using details like ID, email address, phone number(s) and physical address among other details.
Anti-Money Laundering, or AML, refers to a set of regulations and laws that seek to prevent illicit financial activities like concealing and/or transfer of illegally acquired money, tax evasion, and funds misappropriation among other malicious activities.
Crypto is of interest to regulators as it has been identified as highly utilized in money laundering, and Financial Crimes Enforcement Commission (FinCEN), has said that AML compliance is a significant component to the eventual success and stability of cryptocurrency exchanges.
Combating the Financing of Terrorism (CFT) basically involves measures that are aimed at preventing individuals or organizations from financing groups that espouse violence in their activities. CFT laws make it possible for law enforcement agencies to monitor potential terrorist funding initiatives.
The U.S. House of Representatives passed a bill in September 2018 that wanted a task force that would help combat the use of crypto in financing terrorist entities.
Compliance at crypto exchanges
Like with other financial platforms, cryptocurrency exchanges approach the KYC, AML and CFT matter differently depending on the country. However, for those that comply fully, all three involve KYC in four stages:
The first step would see a company determine what to include in the process and offer its user a customer acceptance policy (CAP). The company then moves to the customer identification program (CIP), where it confirms a user’s demographics, matching it to its CAP.
After this, once a customer signs up, the exchange will proceed to continuously monitor a customer’s transactions to make sure that they remain compliant at all times. They also pick out suspicious activities, which then see the exchanges get to the fourth stage: risk management.
In cryptocurrency, the approach to KYC and thus AML and CFT varies greatly- especially depending on whether the exchange is a fiat-to-crypto platform or crypto-to-crypto one.
Some of the top fiat-to-crypto exchanges in the market include U.S.-based platforms like Coinbase and Coinbase Pro. There is also the Winklevoss-owned Gemini, Bittrex, and Kraken. Luxembourg-based Bitstamp and Bitfinex are others.
For crypto-to-crypto exchanges, top exchanges here include OKEx, Binance, Huobi, and HitBTC. The others with a relatively high trading volume are Bibox, Coinbene, ZB.com, and LBank.
Fiat-to-crypto exchanges have to go for KYC, even if not in its entirety, due to the fact that they handle fiat transactions and work with banks. These financial institutions mostly demand that KYC measures be in place before engaging the exchanges.
Some crypto-to-crypto exchanges, because they are not subject to regulations, allow customers to transact without verification. Some have adopted an incremental strategy that sees them go for checks with certain trade limits.
Are crypto exchanges proactive about compliance?
An examination of fiat-to-crypto exchanges, as well as at most of the top crypto-to-crypto platforms, shows that KYC policies are in place, in one or the other form. But what is notable is that many exchanges, even though they do enforce these checks, are proactive enough regarding compliance.
According to Kryptos-X founder Tony Mackay, the minimum these exchanges need to do “to gain respect and empathy from regulators,” is to be proactive. He says that the least should be to “get the on-boarding stage right” as well as being able to detect and deter nefarious activities.
Almost all crypto-to-crypto exchanges, excluding Binance, do not monitor or track users’ transactions to help in detecting potential market manipulation among other fraudulent activities.
Binance partnered compliance firm Chainalysis in October last year, rolling out the company’s Know Your Transaction (KYT) compliance feature that provides for real-time crypto transaction monitoring. Notably, the IRS and FBI also use the KYT feature to track cryptocurrency transactions.
While crypto exchanges have been noted for being reactive when it comes to compliant issues, it is expected stringent regulatory approaches will see the KYC, AML and CFT checks become part and parcel of the crypto industry.
Such measures include suggestions made by the Financial Action Task Force (FATF), which has developed guidelines that will come into effect in June this year.
According to the FATF, countries are mandated to ensure cryptocurrency exchanges adhere to AML/CFT regulatory supervision and that these platforms effectively implement FATF recommendations.
Disclaimer: This is not investment advice. Cryptocurrencies are highly volatile assets and are very risky investments. Do your research and consult an investment professional before investing. Never invest more than you can afford to lose. Never borrow money to invest in cryptocurrencies.