Getting to know KYC: The basics of KYC in crypto

Online privacy is a sensitive issue in the crypto community. While blockchain advocates stand firmly by crypto's anonymity, many regulators worry about the lack of transparency in decentralized systems, seeing the peer-to-peer (P2P) nature of cryptocurrencies as a potential haven for fraud and other illegal activities. To address these concerns, many crypto exchanges now enforce stricter transparency standards, which include collecting verification data through know-your-customer (KYC) procedures.

Although the KYC process can limit crypto traders' privacy, it’s quickly becoming an industry norm. Consequently, it’s important for anyone using KYC-compliant exchanges or platforms to be aware of the trade-offs involved in protecting privacy when buying and selling crypto.

What does KYC mean in crypto?

KYC is a set of procedures that certain centralized cryptocurrency exchanges (CEXs) like Binance and Coinbase, financial platforms offering crypto services, and blockchain protocols facilitating token swaps or other transactions use to verify users' identities. Users do so by providing personal information, such as their name and address, as well as a copy of a government-issued ID, before gaining access to trading services. Crypto exchanges enforcing KYC requirements securely store this data and may share it with relevant authorities if they detect suspicious activities, including fraud or money laundering.

KYC verification discourages illicit activities by linking identities to transactions, aligning with international standards like anti-money laundering (AML) and countering the financing of terrorism (CFT) and ensuring networks meet security and transparency regulations across jurisdictions. By complying with these standards, KYC verification fosters trust in the blockchain ecosystem and supports regulators in preventing criminal activity.

Know-your-customer versus anti-money laundering

KYC and AML share a common purpose but serve different roles. KYC focuses on verifying crypto traders' identities, while AML encompasses a broader set of international guidelines to prevent and detect money laundering. Many exchanges implement KYC identification verification to comply with AML requirements, but KYC is just one aspect of the larger AML framework designed to ensure financial transparency and security.

What are KYC requirements on crypto exchanges? 

KYC’s specific verification requirements may vary slightly depending on the jurisdiction and the exchange, but most KYC-compliant exchanges collect several standard details to meet international regulations. Those include:

• Basic personal and contact information: Before trading on a KYC-compliant exchange, users must provide their full name, date of birth, and home address. The exchange will also request contact details, such as a phone number and email address, to send a verification code for account validation.
• Government-issued ID: Exchanges require a government-issued ID, like a driver’s license or passport, to verify the trader’s identity.
• Selfie: Many exchanges add an extra layer of security by asking users to submit a selfie or video for facial recognition. This biometric data helps the platform cross-reference identity information and reduce fraud risks.
• Proof of residence: Some exchanges may require additional documents, such as a utility bill or bank statement, to verify the trader's address. This provides further proof of residency to meet regulatory standards.

What are the benefits of KYC in crypto?

Proponents of KYC processes argue that they are crucial in helping cryptocurrencies gain wider acceptance by aligning with government regulations. By promoting greater transparency, KYC verification fosters a more secure environment for using digital assets.

• Reduced money laundering and fraud: The main objective of KYC processes is to combat illegal activities in the crypto space. By connecting each transaction to a verified individual, KYC processes enable crypto exchanges to trace digital asset movements and share necessary information with authorities.
• Enhances user confidence: With KYC processes in place, users feel more comfortable knowing their exchange complies with legal standards and actively works to prevent fraud. This focus on transparency and security reassures traders that they’re using a regulated, safe crypto platform.
• Wider institutional engagement: KYC regulations give institutional players like banks and asset managers the legal framework needed to enter the cryptocurrency market confidently, helping to drive broader adoption and increase investment in blockchain technology.
• Potential for increased market stability: The market liquidity introduced by institutional investors could help reduce crypto volatility. As cryptocurrencies become more accessible on KYC-compliant exchanges, the increased number of counterparties can lead to tighter spreads and more efficient trading conditions.

Downsides of KYC verification on crypto exchanges

While the KYC process makes cryptocurrencies more accessible and acceptable, some blockchain advocates worry it compromises online privacy and the principles of decentralization. For these critics, the more personal data exchanges that implement KYC processes collect, the less freedom exists within the crypto space.

• Privacy concerns: KYC processes eliminate the possibility of anonymity. Collecting personal details creates a permanent link between a trader’s identity and their crypto transactions. This information can be accessed by corporations, governments, and international institutions, compromising privacy.
• Risk of centralized data breaches: Besides sharing personal information, users must depend on the exchange's security protocols to protect their data. A single breach could expose sensitive details to malicious actors.
• Potential for censorship: On exchanges that require KYC processes, centralized authorities can freeze accounts and restrict access to funds. Even when crypto is transferred to a private wallet, investigators can trace transactions, blacklist addresses, and block payments, increasing the risk of censorship. 
• Exclusionary impact: Rather than fostering inclusivity, KYC processes create obstacles for individuals in underserved communities. Prospective traders in regions without access to government-issued IDs might face difficulties opening accounts and participating in the crypto economy.

Is there a way to buy crypto without KYC?

While trading digital assets on decentralized exchanges (DEXs) like Uniswap (UNI) or PancakeSwap (CAKE) often bypasses identity verification, most fiat on/off ramps require KYC processes. For example, purchasing cryptocurrency on MetaMask typically involves using KYC-compliant services such as PayPal or credit/debit cards. Similarly, many crypto ATMs that once facilitated transactions without KYC now enforce these requirements. On DEXs, users connect a self-custodial wallet to the decentralized application (dApp) and trade directly without centralized oversight or verification.

DEXs provide a way to swap crypto without KYC verification, but they come with risks. The lack of regulatory oversight compared to exchanges requiring KYC processes makes DEXs more susceptible to scams, particularly with newer altcoins with little market history. DEXs also tend to have lower liquidity than KYC-compliant CEXs, which can make it more difficult for traders to find counterparties or achieve favorable prices. Also, because DEXs are relatively new, they can be prone to smart contract bugs, hacks, and technical glitches. And since there’s no third-party customer support, resolving issues can be challenging.

For traders still interested in using DEXs, platforms like CoinMarketCap and CoinGecko provide lists of top DEXs by liquidity and reputation. As with choosing a reputable CEX, it’s wise to use DEXs with a solid track record of success in the crypto market.

Balance security and convenience with CoinTracker

Regardless of where you stand on the KYC verification process in crypto, regulators are increasingly scrutinizing digital asset transactions, including those handled by tax authorities. The safest and simplest way to stay compliant with crypto tax regulations is to sync all your wallets and exchange accounts in one convenient CoinTracker dashboard. Our portfolio tracker gives you real-time insights into your web3 portfolio and creates IRS-ready tax forms to ship to a CPA, TurboTax, or H&R Block. 

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.