AML And KYC – Key for Crypto Adoption
Decentralized ledger technology (DLT), more commonly referred to as the blockchain, was first introduced by Bitcoin, making it possible to transact value without the need for intermediaries. Similarly, among several other characteristics, blockchain users transacting cryptocurrencies remain pseudonymous. Identified by wallet addresses that are strings of alphanumeric characters, it can be challenging to associate people in the real world with their wallets on the blockchain. To not much surprise, blockchain pseudonymity allows individuals and enterprises involved in illicit activities to launder their money.
On the contrary, the traditional financial industry relies on frameworks to keep out money linked to illicit activity. Governments and regulators made it mandatory for financial institutions to implement sophisticated Anti-Money Laundering (AML) and Know-Your-Customer (KYC) protocols. Fintech platforms must also abide by these guidelines and prevent money from questionable sources from entering their books. The lack of necessary frameworks like AML and KYC in the crypto industry adds difficulties to its adoption.
AML And KYC – What Are They?
AML and KYC are frameworks implemented by banks, financial institutions, platforms, and money businesses to prevent money laundering by terrorists, drug rings, and other criminal enterprises. The broader AML framework includes KYC as one of the parameters, and the guidelines companies follow while creating these protocols are aligned with local regulators' laws and policies.
The AML protocols implemented by financial institutions allow them to detect, track, and report suspicious transactions to local authorities. KYC procedures involve users providing detailed information about themselves to institutions while opening bank accounts or trading accounts on platforms. Essentially, AML and KYC allow the companies you use to hold, transact, and invest your funds to know who you are and where your funds come from and go. In addition, the transparency provided to companies and institutions allows them to detect and flag funds from shady sources.
AMC and KYC are mandated worldwide to prevent issues like terrorist funding and legitimizing funds from drug gangs and cartels. The Financial Action Task Force (FATF), an international organization, was instrumental in designing the standards adopted by regulators across the globe and turning them into national laws. These laws first applied to institutions and platforms dealing with fiat currencies but have been expanding to crypto businesses worldwide because of crypto's increasing popularity, followed by the consequent increase in criminal activity in the segment.
How AML And KYC Work In The Crypto Industry
Regulators are cracking down on crypto platforms with several regulations to protect investors and cryptocurrency users from being defrauded. The amount of theft and scams in the crypto segment is steadily rising each year, as reported by several crypto analysis firms. Concurrently, criminals are using crypto to wash their illegally obtained funds. Until recently, everyone could open accounts on crypto platforms without any KYC formalities. Taking advantage of this fact, criminals exchange their crime money for one or more of the crypto coins and tokens available on the platforms. Further, using DeFi apps and crypto mixers makes it possible for criminals to cut the trail on their funds.
Centralized exchanges are the first point of contact for most people, including criminals, wanting to exchange their fiat for crypto. Due to the significant criminal incidents occurring in the crypto industry and other security reasons, regulators are rightfully enforcing their AML and KYC policies on crypto platforms. In addition, all countries allowing crypto businesses to register for licenses need them to provide accurate AML and KYC framework plans to receive the permissions to operate.
Beyond identifying and reporting suspicious transactions by monitoring them continuously, AML frameworks mandate crypto businesses to share details of the customers and transactions when they cross a certain transaction threshold. The mandate is part of a regulation called the Travel Rule recommended by the FATF. In addition, KYC procedures require platforms to register users with their legal names, validate their government documents as proof and assess the risks presented by the potential customer based on rigorous background checks and transaction history.
Together AML and KYC frameworks are beginning to secure the crypto industry from all kinds of criminal activity – thus addressing one of the main issues barring the mass adoption of cryptocurrency.
The Importance Of AML and KYC For Crypto Mass Adoption
With regulators cracking down on the crypto industry, AML and KYC mandates are becoming the norm. In addition, centralized exchanges, stablecoin providers, and various DeFi applications are mandated to implement frameworks that keep criminals out and maintain transparency of all transactions occurring within the platforms.
Of course, these frameworks are necessary to operate legally within many jurisdictions because they are being enforced through stringent laws. Their implementation alludes to the fact that the companies are compliant with regulators. Thus, they are trustworthy and safe to store and handle funds. Compliance is leading to an increase in the confidence of investors and crypto users who were wary of the practices followed by cryptocurrency platforms due to a lack of regulations. Moreover, the collective implementation of AML and KYC protocols by crypto companies worldwide builds trust in society about the crypto industry.
Compliance further secures platforms from becoming havens for criminals to launder and transact funds. Detecting suspicious activity through AML protocols makes it possible to differentiate between your average crypto user and criminals. It allows platforms to report and prevent the activity. Hence, platforms can keep themselves safe from the liabilities which ensue after authorities notice laundering efforts on platforms. Their operations can be paused or stopped, and they can be subjected to heavy sanctions. AML and KYC frameworks keep businesses safe from such incidents and remove a lot of uncertainty experienced by service providers and platform owners.
Consequently, more platforms can be expected to begin operations in the crypto industry, driving up competition and innovation in the space. Investors are also interested in platforms that are stable and secure out of other factors that justify their investments. As more investors set foot in crypto, we expect more platforms to mushroom.
Platforms are also using AML and KYC frameworks to notify their user bases about wallets associated with criminal activity, keeping them aware of the people behind the addresses they transact with. That detection level prevents users from being fleeced or scammed by hackers and helps ensure that their funds are not routed to the wrong entities. It also helps keep users out of legal trouble. In addition, platforms are further blacklisting such wallets from transacting or storing funds, making it possible for users to use them without constant worries of losing funds to hacks, which crypto users often experience.
Cryptocurrency has been associated with criminal practices for most of its existence. While criminals have been turning to crypto to wash their funds, the lack of legislation and regulations over the crypto industry has enabled such behaviors. The prominence of cryptocurrency is changing as lawmakers introduce legislation requiring crypto companies to set mechanisms to reduce and prevent criminal activity like their TradFi counterparts. AML and KYC frameworks are emerging as the saviors of the crypto industry, making it safer for companies and stakeholders to profit in this space. The tarnished image of the crypto industry is now being revived thanks to AML and KYC compliance, and the industry is expected to grow exponentially.
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