KYC and AML Practices, Sanctions, Crime, Fraud, all are Facts of Life for Centralized Exchanges, and they have to Cope.

The application of Know Your Customer and Anti-Money Laundering procedures is mandatory for centralized exchanges seeking to go global. But even the exchanges from the top of the list cannot always comply with all of the requirements of international sanctions regimes to avoid lost revenues. This is where the operations of KYC procedures, VPN services, AML practices, sanctions regimes, and even the actions of international regulatory authorities collide to produce the truth of the market about them all.

Fighting Crime and Fraud as a CEX

Centralized exchanges prove their namesake for a reason – since they have centralized authorities and simply operate blockchain-based platforms. The reason they are centralized is because they operate across the globe and deal with millions of users who transfer billions of dollars and other funds in trading volumes across these platforms on a daily basis. To be able to act as forwarders of such volumes of funds, the exchanges have to be international and, therefore, must comply with both the local and global financial regulations in effect across various jurisdictions of their operation. This creates a caveat, which implies that the exchange has to abide by internationally recognized KYC, or Know Your Customer, and AML, or Anti-Money Laundering procedures.

Both of these requirements imposed on users of centralized exchanges are quite contrary to the core values of decentralization and blockchain, since they identify users, stripping them of privacy and anonymity, and by giving centralized exchanges the ability to monitor and trace funds going through them. Both of these mechanisms act as extensions of global authorities of oversight, such as the US financial authorities or those of the European Union.

KYC and AML do impose certain headaches on centralized exchanges, but even the complexity of such procedures can be streamlined to include all of the necessary operations that would allow a business to comply with global regulatory requirements and at the same time maintain the trust of its users.

The Lay of the Land

No centralized exchange can ever control the money that is being transferred through its channels up until the moment it is already located in its vaults. Once the funds are on the platform, they can be monitored, traced and, if necessary, stopped. However, the exchange cannot be held accountable for the intentions of the users who use it thanks to its convenience, lower commission fees or generally favorable conditions. If such a correlation were to be made, it would imply that any scammer posing as a major corporation through phishing practices would, in essence, cast the shadow of doubt about money laundering onto the corporation itself, which is utterly illogical and untrue.

To be able to identify such users, exchanges rely on KYC procedures that link to specific user accounts on other platforms. Since the data is shared and a single email address is sufficient to get a firm hook on a potential suspect, the exchange’s compliance and security personnel can contact the authorities in the targeted individual’s jurisdiction and get an arrest of search warrant. Such interconnection and cross-verification of individual personal data for ensuing identification lies at the heart of centralized exchange security layers and divulges the essence of KYC.

Once a suspect is identified, the authorities can rely on KYC for fact-checking and ensuing extraction of funds from a suspected platform, thus creating a firm link between fraudulent funds and the perpetrator. Exchanges can act as important intermediaries in the process of crime prevention by stopping money-laundering transactions in time before the funds are transferred to a mixer service for ensuing anonymization.

The offline environment is actually the space for illicit activities, not exchanges, since the perpetrators are well aware of the practices and procedures applied by centralized platforms. They are aware that their activities are being closely monitored and can be traced if they ever stumble in the process. Should any criminal, known or suspected, try to use a major centralized exchange like Binance, they would be immediately identified and apprehended, since their data is very likely in the system and is being kept tabs on.

Anonymity

There is no such thing as anonymity in the online space, since everyone and everything can be traced. VPN services are not a panacea, since crypto exchanges do not block such services by default for a number of reasons. First, it is not illegal to use a VPN, and secondly, some VPNs are quite useful for online investigation purposes. The authorities know that criminals use VPNs and intentionally trace VPN activity on targeted or suspected accounts, knowing their patterns of operation. In conjunction with other factors, a VPN usage pattern can reveal the identity of a suspected individual and either lead to their whereabouts or even to the funds they are trying to launder or hide.

A VPN will never stop the authorities from identifying a target individual, since it is not the masked location or IP address that gives out their identity, but a combination of factors that can be combined to create a profile, which is then easy to trace.

KYC and Sanctions

Sanctions mean close to nothing in online space, being practically instruments for show of force, rather than actual tools capable of stopping any kind of activity from happening. For example, even if the United States imposes more sanctions on Iranian citizens, said sanctions will have absolutely no effect on Iranians living outside of Iran. The OFAC – the Office of Foreign Assets Control, the U.S. agency that enforces sanctions, has no control or authority over such citizens once they step outside the sanctioned jurisdictions and no other country will ever recognize the effects of such sanctions on their territory.

The United Nations has some global influence in terms of sanctions, such as those imposed on North Korea or Syria, but those sanctions apply only in jurisdictions that recognize the effects of such. As for United States sanctions, they are only applicable according to the legislation and enforcement of the United States alone, effectively limiting their scope, effect, and action quite severely from a geographic standpoint. In fact, it is illegal from an international standpoint to pursue Iranian citizens living outside or Iran for breaching United States sanctions imposed on Iran, for instance.

Furthermore, it is illegal for companies in the European Union to comply with the sanctions imposed by the United States against Iran. The rules governing the interrelation between Europe and the United States regarding the enforcement of such sanctions is vague, contradictory and counterproductive for the economy of the European Union itself.

It is quite clear that KYC procedures become a rather vague and nominal instrument in this regard if some jurisdiction is seeking to enforce some sanction against the citizens of a specific country.

Centralized Approach to Sanctions Enforcement

Major exchanges like Binance are technically in an illegal position from the standpoint of other jurisdictions when it comes to compliance with United States sanctions requirements. Such contradiction is normal and acceptable, since exchanges have to operate globally and cater to the citizens of many countries. If they do not, they risk both revenues and reputations, since the crypto industry is quite a tight-knit one and it does recognize the fact that if the interests and freedoms of a specific group of users is threatened by a platform, there is a chance that the interests of all other users are at risk in the future.

The approach taken by centralized exchanges is quite in line with the one of regular banks, which simply ignore sanctions and routinely open banking accounts for citizens of sanctioned countries if they are residing outside the sanctioned jurisdictions.

As such, KYC procedures are also quite a nominal, but useful instrument, that can cost a centralized exchange a hefty amount of funds to maintain, or as payment for compliance with them in terms of lost revenues.

Key Takeaways

KYC and AML procedures are mandatory and require centralized exchanges to employ entire networks of compliance departments to ensure that all monetary flows are monitored to stop illicit activities. However, there are simpler approaches that can be directly integrated into platforms seeking to comply with such procedures. The AMLBot service provides all the functionality of KYC and AML in automated and convenient fashion to ensure that the integrating platform is in full compliance with international requirements in the same fashion as even the top exchanges on the market.