As the world becomes more and more connected with business activity conducted in real-time, there has arisen the need for regulations. Countries across the world have reached a consensus about monitoring transactions and suspicious activities, to prevent the financial system from being used for crime, fraud or terrorism. Core to this regulatory framework, is KYC and AML.
So what is KYC?
If you have been to a bank to open a new account or approached for a car loan, you will be familiar with the process of KYC or Know Your Customer. It refers to the process of submitting documents that identify you – your name, DOB, address, or Tax Identification Number (TIN). These details are authenticated before you are registered with the bank, for a new account or a loan. KYC onboarding is a necessary global function to check the person is indeed who they say they are.
The purpose of KYC is to ensure that minors, undocumented immigrants, or individuals with criminal histories are restrained from using a service they are not authorised to use.
AML refers to the Anti-Money Laundering policies and regulations that require financial institutions and businesses to monitor their clients to prevent financial crimes. These regulations are administered by the regulating authority in a country, with detailed provisions on AML compliance. Businesses, companies, professionals and organisations that are “reporting entities”, are required to comply with KYC onboarding and monitor customer transactions. The process of AML compliance is continuous, with ongoing customer due diligence.
The purpose of AML laws is to prevent a business from being used for financial crimes, and to ensure the financial economy is not affected by large illicit money movements.
Cryptocurrency – the new-age virtual currency
Cryptocurrency is a virtual currency based on encrypted techniques. The method makes use of limited entries called transactions. Once a transaction is confirmed, it becomes a permanent feature, as it cannot be reversed or forged. The security feature of cryptocurrency uses blockchain technology, the most secure technology medium today.
The “miners” confirm transactions that create the cryptocurrency. They put their stamp of legitimacy and spread them in the network to be part of the blockchain. These transactions become digital cash in various forms – bitcoin, litecoin, etherum, and more. Eventually they enter the financial system without any government intervention or control on currency creation.
The interrelationship between KYC, AML and Cryptocurrency
Cryptocurrency can be created by an IT savvy individual or crypto “miner”, and circulated in the network to become digital cash. There is no KYC involved in the process. As the essence of blockchain technology is encryption, there is no way of knowing the identity of the individual’s involved making void the KYC. The blockchain technology also makes it impossible to monitor client activities, the purpose of payments and so on. Thus, AML compliance is not doable in the crypto system.
Why there is need for a law to ensure AML/KYC compliance of Cryptocurrency exchanges
Cryptocurrencies enter the financial system without any knowledge of the source of creation, parties involved, or purpose for which it is used. This gap has been used by money-launders, terrorist and criminals for funding their operations. Besides, cryptocurrency is found to fund illicit and unlawful activities like purchase of guns and drugs; and underworld operations in the “dark web” like bomb making.
This defeats the purpose of laws meant to regulate criminal activities, including the AML regulations. Therefore, there is an urgent need for a law that addresses the AML/CTF compliance as well as KYC. This will in the least, bring some transparency at the end-user level, and help monitoring of business activity.
A review of current and emerging regulations around cryptocurrencies
Cryptocurrency exchanges facilitate the trading of cryptocurrency coins or tokens. So regulators are now addressing these touchpoints or gateways for regulatory compliance.
In Australia, the Australian Transaction Reports and Analysis Centre (AUSTRAC) has made amendments to the AML/CTF Act 2006 to ensure compliance by digital cryptocurrency exchanges. The Anti-Money Laundering and Counter-Terrorism Financing Amendment Bill 2017 requires “Providers of registrable designated remittance services or registrable remittance network services” to register with AUSTRAC. Crypto exchanges are now required to sign up with the Digital Currency Exchange Register for KYC compliance. Most significantly, exchanges are required to submit reports of suspicious account activity, and any international transactions paid in cash exceeding AUD $10,000. Customer records are to be maintained for a period of seven years.
Such regulatory mechanisms are being introduced by many countries including the EU, with the intention of allowing a level regulatory field. The aim is to promote a safer marketplace for investors while putting a framework of rules for compliance.