Limitations of KYC in Crypto Adoption

Data & Research / 15.07.2021

The recent rise in fraud, money laundering, and tax evasion cases has led financial institutions to focus on how they can apply underlying controls on their counterparts. Regulators worldwide have developed an interest in the frenzy and are continuously developing regulatory moves targeting market actors. 

The aim is to ensure financial institutions align with the current security practices and measures like Know Your Customer (KYC). Several exchanges have employed their compliance to meet measures that have been set while others follow suit to avoid challenging unwanted circumstances. 

In particular, a recent Binance hack on May 7 had unnerving aftermath after 7,000 bitcoins (worth $40 million at the time) got stolen. As a result, the company’s founder and CEO, Changpeng Zhao, decided to implement and conduct an important security update that would include an upgrade to Know Your Customer measures. 

As KYC gains adoption among top cryptocurrency exchanges, its participants, and the market at large, certain defects prevent KYC from reaching worldwide adoption.

Understanding Know Your Customer

Know Your Customer (KYC) is a set of measures that an institution or a company employs to approve the identity of its customers or users. However, KYC measures vary across different jurisdictions and companies. Yet, the fundamental foundation of KYC is the collection and verification of customer’s means of identification like phone numbers, government-issued identity cards, an email address, a physical address, biometric verification, etc. 

Initially, it integrated the identification procedures into a bank’s Anti-Money Laundering (AML) policy, but now a broader scope of financial and non-financial institutions are liable to oblige. That’s the reason why the U.S. Financial Crimes Enforcement Network (FinCEN) introduced a new requirement in May 2018 for all banking institutions to identify any legal entity before opening accounts.

Know Your Customer aims to mitigate criminal elements from leveraging financial institutions for money laundering and criminal activities. Every financial institution and business needs KYC measures to aid in managing their risks in a well-judged manner. Every jurisdiction and financial institution frames its KYC procedures following key elements: customer acceptance policy, customer identification procedures, monitoring of transactions, and risk management.

As cryptocurrencies continue to gain traction in our advancing digital market, we have to prepare for continuous global regulations and fraud prevention requirements in the financial realm.

Limitations of KYC

Know Your Customer is essential to eliminate money laundering, stop counter-terrorism from suspicious financial activities, and ensure that banks can significantly manage their risk by mitigating financial fraud. Nevertheless, there are certain specs about Know Your Customer that limit the platform from attaining mass adoption.

Know Your Customer is a real-time killer. The verification process required by financial institutions is often time-consuming, which may hinder clients with emergency financial needs. The process roughly takes up to 30 business days, and not many are willing to follow that path.

Another problem with KYC procedures is that it’s often quite expensive. Nobody wants to spend a dime for verification. Know Your Customer measures require exchanges and financial institutions to register with regulatory bodies and pay for verification. 

The costs come from sending customer documents to third parties for verification. Unwanted extra fees like these are what hinder crypto adoption. KYC procedures also make financial institutions liable to security concerns. 

Know Your Customer requires collecting sensitive customer data, and there are concerns that it might be vulnerable to hackers that may take advantage of weak security procedures. In addition, customers worldwide are wary of hackers, and such security concerns might limit crypto from achieving widespread adoption.

Even though KYC portrays a blockbuster potential for jurisdictions around the world to adopt crypto finally, it’s almost impossible. KYC measures can’t scale with increased regulations as several nations are building their own central bank digital currency. In particular, just recently, 

China introduced its own central bank digital currency, the digital yuan. China decided to digitize banknotes and coins in circulation to curb counterfeiting and also to speed up cashless payments in the country. A move like this limits other countries from using a particular digital currency since it’s only accessible in one jurisdiction only. It will ultimately limit crypto from reaching widespread adoption.

For crypto to achieve adoption, there is a need to prove the viability of blockchain technology. For that reason, KYC measures require a blockchain infrastructure that can manage high levels of complexity and potentially accommodate thousands of transactions. Unfortunately, at the moment, there is no such crypto, but the continuous growth of cryptocurrencies gives hope for the future.

There might emerge concerns about the return on investment because of high costs in developing, implementing, and migrating systems to a blockchain KYC-enabled solution. These costs may limit cryptos from reaching adoption. In addition, KYC requires access to government databases and personal user identification data, which is crucial in achieving a blockchain-enabled KYC cryptocurrency. 

Since this information is significant for verification, it might seem risky for some to surrender their information. First of all, cryptocurrencies are decentralized, and users are anonymous, which portrays the extensive interest in crypto. However, since KYC requires users to surrender their personal and bank details, it tends to defy the whole crypto concept. 

Many people might be skeptical about trying the new KYC solution, limiting cryptocurrencies from adoption.

Conclusion

The gatekeepers of the monetary system, banks, and other financial institutions must possess high responsibility to mitigate financial crime. Therefore, these institutions need to be wary while establishing KYC measures because compromising customer’s data can cause penalties of up to 2% of a company’s global annual income.

The main point of disadvantage in the cryptocurrency realm is achieving mass adoption. It might seem impossible since many crypto platforms have integrated Know Your Customer to a bare minimum. The process of having a single KYC data service provider can be costly and cumbersome to some, but its phenomenal potential could see cryptocurrencies achieving significant results in the future. 

The cryptocurrency realm needs to overcome some of the hurdles mentioned above to achieve success and reach adoption. In addition, for KYC to impact crypto globally, there have to be proper technological improvements to maintain a frictionless experience for crypto adoption.

Adam is an outgoing young lad who likes adventures and discovering new things. Despite his boring life, he loves writing about cryptocurrencies and exploring what blockchain technology can do for the coming digital world where all adventures will be virtual.