Cryptocurrencies and crypto exchanges have grown tremendously in the last few years. While the market value of cryptocurrencies was approximately USD 793 million until 2019, it is expected to grow above USD 5,191 million by 2026.

In this article, we will discuss KYC (know your customer)  and AML (anti- money laundering) regulations, and look at 5 different ways in which cryptocurrency exchanges can easily secure their systems while also ensuring regulatory compliance.

The Ongoing Battle with Money Laundering and Terrorist Financing

Rapid growth in the cryptocurrency did not come without some disruptions. Combating fraudulent activities, such as terrorist financing and money laundering, has long been a major challenge for this industry worldwide. Criminal organizations cause damage to the industry by hiding the source of illegally obtained funds and passing the cash through a series of transactions, making the funds untraceable.

All attempts in preventing incidents of money laundering are known as Anti-Money Laundering (AML) procedures. To mitigate financial crimes, regulatory authorities have introduced strict rules and regulations that are mandatory in various industry sectors, including cryptocurrency.

As the cryptocurrency industry was late to fulfill AML obligations, criminals took advantage and made various successful attempts of laundering dirty cash and financing terrorist activities. Considering such threats global regulators took action and introduced KYC and AML regulations for virtual currencies. Let’s take a look at the two regulations that are at the forefront of ensuring security for crypto exchanges.

#1: FATF’s Recommendations

In June 2019, the FATF (Financial Action Task Force) published “Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers”. According to this guide, the cryptocurrency industry became liable to comply with AML and counterterrrosim financing rules as imposed on other financial institutions. Member countries of the FATF are bound to comply with these measures, particularly to ensure the transparency of crypto transactions.

–         The Risk-based Approach

The FATF’s guidance for a risk-based approach includes information regarding following:

  1. How virtual asset service providers and virtual asset-related activities come under the scope of the FATF Recommendations
  2. How countries and regulatory authorities should apply the FATF Recommendations regarding virtual assets and virtual asset service providers
  3. How the FATF Recommendations apply to other entities, such as banks and securities brokers, that participate in or enable virtual asset activities

#2: 5th AMLD

The fifth anti-money laundering directive, or AMLD5 for short, was introduced by the European Union in July 2018. Although the 5AMLD is a revised version of the 4AMLD, it introduced updates in the treatment of virtual currencies. These updates are listed below:

 

  1. Virtual Currency Exchange Providers (VCEPs) And Custodian Wallet Providers (CWP) are to be considered as financial institutions
  2. They are subject to the same AML and CFT regulations as imposed on other financial institutions
  3. They are also required to get registered with EU local authorities
  4. KYC (Know Your Customer), CDD (Customer due Diligence) and SAR (Suspicious Activity Report) is mandatory
  5. When necessary, they are required to submit customer’s PII (Personally Identifiable Information)

AML, CDD and KYC for Customer Onboarding

To stay compliant with mandatory regulations, cryptocurrency exchanges need to implement identity verification to some extent to weed out fraudsters. Most cryptocurrency platforms have adopted KYC processes for this purpose, that require customers to go through an automated identity authentication procedure before onboarding their platform. Examples of data collected in the KYC process include:

  • Customer’s full name
  • Their DoB
  • Official ID document
  • Proof of address

The KYC process can be categorised into two categories. These are CDD (Customer Due Diligence) and EDD (Enhanced Customer Due Diligence). CDD simply involves the basic identification procedure to profile potential customers. On the other hand, EDD is performed on high-risk customers through additional profiling measures and questioning. With the help of both of these processes, risk can be successfully mitigated by identifying customers with a poor credit history or those having a record of AML transgressions.

Key Takeaways

  • Cryptocurrencies and crypto exchanges have grown tremendously in the last few years
  • Counter Terrorist financing and money laundering has long been a major challenge for the crypto world
  • To mitigate financial crimes, regulatory authorities have introduced strict rules and regulations that are mandatory
  • Important regulations include the FATF’s Recommendations and the EU’s 5AMLD
  • KYC, CDD and AML procedures are mandatory for cryptocurrency exchanges to stay in compliance by regulatory obligations

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