What is KYC?
With the ever-growing threats on security in the web3 space, institutions have been enforcing more stringent KYC measures. Learn about Know Your Customer, its components, and why it is important.
Topics to read before diving into this course:
At the end of this course, you will be able to answer the following questions:
What is KYC?
What are the components of KYC?
Why is KYC important?
What is KYC?#Copy URL to this article section
Know Your Customer/Client (abbreviated as KYC) is a series of procedures for validating a customer's identity before or during dealings with banks and other financial institutions.
Money laundering, terrorism financing, and other common fraud schemes can all be thwarted by following KYC laws. Financial institutions can more precisely spot suspicious behaviors by first authenticating a customer's identity and intentions at the time an account is opened, and then studying their transaction patterns.
Banks and financial institutions follow KYC laws for security.
Decentralized Finance (DeFi, i.e. when transactions are made directly and are handled by smart contracts) offers endless prospects because it is open, borderless, and permissionless, but it also comes with the risk of fraudulent activity.
KYC in the web3 space is proving to be difficult due to an ever-changing regulatory landscape and relatively new criminal tactics. As a result, institutions that utilize cryptocurrency should be mindful of the risks associated with the space such as transaction anonymity when they build and deploy their KYC solution.
What are the components of KYC?#Copy URL to this article section
KYC has three main components: Customer Identification Program, Customer Due Diligence, and Continuous Monitoring.
Customer Identification Program#Copy URL to this article section
A passport can be submitted for identity verification.
Customer Identification Program (CIP) is for verifying if the customer is who they say they are. In this process, an institution will ask for identifying information from the customer.
Every financial institution has its own CIP procedure based on its risk profile. Some organizations may ask an individual for a government-issued ID, such as passports or driver’s licenses. Others might ask corporations to provide business-related documentation, like business permits or financial statements.
Customer Due Diligence#Copy URL to this article section
Financial institutions assess the customer's transactions.
Customer Due Diligence refers to the extensive risk assessment and examination conducted by financial institutions.
Financial companies look at the types of transactions a customer might make in the future in order to spot unusual (or suspect) behavior. The institution can then assign a risk rating to the customer, which will affect how much and how often the account is monitored.
Continuous Monitoring#Copy URL to this article section
Accounts are regularly checked for unusual or suspicious activities.
Continuous Monitoring refers to financial organizations' ongoing surveillance of their customers' transactions for suspicious or unusual conduct.
The organization regularly checks transactions and flags those that seem suspicious or unusual. These are then reported to regulatory authorities depending on where the organization is based.
Why is KYC important?#Copy URL to this article section
Generally, financial institutions that deal with consumers during the opening and maintenance of accounts find KYC to be necessary. Standard KYC procedures are often followed when a company onboards a new client or when an existing client gets a regulated product.
Some institutions in traditional finance that use KYC are banks, financial cooperatives, and lending platforms. Centralized cryptocurrency exchanges such as Coinbase and Binance also utilize this process.
Binance is a centralized exchange that enforces KYC measures.
Regulators can apply significant, reputational, and financial fines if you fail to follow the KYC process. Customer background checks in order to prevent fraudulent activity are critical in industries where there is a high risk of financial fraud and money laundering.