What is KYC in crypto?
KYC is a mandatory aspect of international anti-money laundering laws (AML laws). The purpose of KYC is to help authorities track and prevent people from engaging in illegal activities like terrorist financing or concealing money associated with criminals.
As the name suggests, KYC focuses on gathering official ID documents related to prospective clients. Cryptocurrency exchanges with KYC policies usually ask customers to submit state-approved documents like a passport or driver's license to verify their identity. The company scans this paperwork against public records to see if a client has a criminal history. If the business finds that a customer has a low-risk profile, it’ll likely allow them to start trading crypto.
Remember that the KYC process continues even after a user starts trading on a crypto market. Companies can monitor their customers' activities and report suspicious behavior to federal or state authorities. Customers also have to constantly update their KYC information if there's a significant update, such as a name change or a new address.
Why is KYC so relevant in the crypto industry?
KYC is relevant for all trading platforms, but it's particularly important on crypto exchanges. Since the early days of Bitcoin, crypto has gained an association with nefarious online markets like the Silk Road. Crypto critics often argue the anonymity these digital tokens provide makes them well-suited for illicit activities.
In response to these concerns, many governments made KYC on crypto exchanges a central part of their crypto compliance laws. Since most people use centralized crypto exchanges (CEXs) to buy and sell tokens, they're an easy place to track user activity.
To comply with federal regulators, most major CEXs only allow customers who complete KYC registration onto their platforms. Without instituting KYC requirements, CEXs can face severe penalties should governments discover criminals or terrorists used their site. In many countries, all crypto exchanges need to use KYC to remain in business.
A government’s idea is to ensure that people who on-ramp and off-ramp into crypto aren’t bad actors, as they have less visibility once people begin to transact with crypto.
What is the KYC process?
The KYC process may vary between crypto exchanges, but most involve providing detailed personal information and submitting a government-issued ID. Most CEXs ask customers to submit either a government-issued driver's license or a passport to complete the identity verification process. Here are some other pieces of information customers provide:
- Full name
- Date of birth
- Home address
- Proof of residence
- Email address
- Telephone number
- Marital status
- Average yearly income
- Source of funds
Crypto exchanges may ask new users to send a selfie during the KYC process. They then use machine learning algorithms to verify if the image matches the one on a user’s passport or driver's license.
Most often, it doesn't take longer than a day for new customers to know whether they passed the exchange's KYC requirements. If a user has less documentation, the process may be more time-consuming, as it’s more difficult to verify that a user isn’t a bad actor.
Which crypto exchanges require KYC?
Major CEXs like Coinbase and Binance often require KYC. While not all crypto exchanges demand KYC information, most of the largest crypto companies ask for personal information and IDs to use their platforms. Even if a crypto exchange doesn't require KYC, it may majorly limit the financial services non-KYC clients can access. For instance, a non-KYC customer may have low daily purchase or withdrawal limits.
In addition to CEXs, many fiat-to-crypto services require personal identification to use their platforms. For example, people who want to use MoonPay, PayPal, or Venmo to invest in crypto need to submit KYC information.
What are the advantages and disadvantages of KYC regulations?
There are countless arguments in favor and against KYC for crypto. Let's run through a few of the major points on both sides of this issue:
Pros of KYC
- Gives crypto more legitimacy: Strict KYC requirements can help reduce the stigma surrounding crypto's Silk Road past. More retail investors are likely to see the positive aspects of crypto if they know authorities can easily target criminals.
- Protects the reputation of CEXs: Similar to the last point, KYC gives CEXs a more professional reputation in the financial industry. Like traditional financial institutions, CEXs are now held to a high standard for compliance, safety, and transparency.
- Makes it easier to target criminals: The key purpose of KYC is to help federal and state investigators quickly track down money launderers and criminal organizations.
- Enhanced consumer protections: When people lose crypto in a non-custodial crypto wallet, there's no authority they can turn to for assistance. However, those who hold crypto on a KYC exchange have a chance to recover lost funds due to hacks.
Cons of KYC
- Potential customer discrimination: Some potential crypto investors may live in a region where the local government doesn't supply all the ID paperwork a crypto exchange needs. It's also possible for crypto exchanges to bar customers who live in sanctioned countries, which can discriminate against many people who want to get involved with crypto. Worldcoin attempts to have a broader and more fair coverage than institutions that depend on KYC.
- Risk of a centralized data breach: Customers on a CEX must trust that their chosen platform will protect their personal information. Even if a CEX doesn't intentionally leak its clients' details, there's always the risk that a hacker can get into a CEX's database and steal sensitive data.
- KYC centralization reduces crypto anonymity: Even if people transfer crypto off a KYC exchange, blockchain analysis firms can easily link their CEX account with their crypto wallet address. This ease of tracking weakens anonymity in Web3.
Can people buy crypto without KYC?
There are a few no-KYC crypto exchanges, but most high-profile CEXs have some degree of KYC. Some crypto exchanges still don't require KYC, but they may limit financial services to those who don't submit KYC details. Also, non-KYC exchanges are usually small, illiquid, and have a poor track record in the crypto community.
However, decentralized exchanges (DEXs) on smart contract blockchains don't require KYC. DEXs like Uniswap and Curve Finance only require users to connect their crypto wallets to make token swaps. These sites use automated smart contracts and liquidity pools to provide a peer-to-peer trading experience without KYC. However, to on-ramp money into DEXs or crypto wallets, companies should consider verifying via KYC.
Most dApps (decentralized applications) on blockchains like Ethereum don't require KYC documentation. This includes crypto lending sites like Aave, play-to-earn games like "Axie Infinity," and NFT (non-fungible token) marketplaces like OpenSea.
However, there are some instances where Web3 developers may require users to link their crypto wallet with KYC information. For example, in early 2022, the NFT studio Yuga Labs required anyone who wanted to mint land NFTs for its metaverse "Otherside" to submit KYC information.
Lastly, people can buy crypto from physical Bitcoin ATMs without supplying KYC information. These machines typically allow customers to purchase major digital currencies like Bitcoin or Ethereum with fiat and transfer them to a crypto wallet. Although most Bitcoin ATMs don't require KYC, they tend to have low withdrawal limits, few token options, and high transaction fees compared with many CEXs.
Are there risks to buying crypto without KYC?
Buying crypto on a non-KYC exchange is against federal law in most countries. Many countries like the U.S., South Korea, and Canada require all legitimate CEXs to collect KYC data from their customers. Crypto companies that don't comply with crypto compliance rules risk going out of business.
Depending on your country's laws, it may be off-limits to use a crypto exchange without submitting KYC documents. Remember that crypto holdings are taxable under federal law. Those who fail to provide this information (even if they used a non-KYC exchange) can face tax evasion penalties.
Since DeFi (decentralized finance) is relatively new, trading tokens on DEXs is still unregulated in most jurisdictions. However, just because there aren't clear laws governing DeFi doesn't mean it's legal in every country. Indeed, the U.S. government banned the DeFi site Tornado Cash in 2022 after discovering North Korean hackers gained access to it. Those who use DeFi must stay up-to-date on their state's regulations and always share relevant information with tax authorities.
One of the greatest challenges in cryptocurrency is verifying a wallet holder's identity without invading their privacy. Although KYC helps businesses and protocols monitor suspicious behavior, it eliminates the anonymity Web3 promises. If the crypto industry is serious about promoting privacy, there must be an alternative solution.
At Worldcoin, we aim to eliminate the need for intrusive KYC requirements with our Orb device. Using advanced eye-scanning technology, Orb can link crypto wallets with unique users without collecting personal data. To learn how our Orb device can revolutionize privacy in the cryptocurrency market, subscribe to our blog.