What Crypto Businesses Must Know

With the semi-anonymous nature of cryptocurrencies, digital finance opened doors for misuse. To counter this, regulators globally are imposing Know Your Customer (KYC) and Anti-Money Laundering (AML) rules on crypto firms. 

In this post, we’ll explore what KYC in crypto means, when it’s required, how it works, and how a crypto business can adopt it.

What Is KYC?

KYC, short for “Know Your Customer”, is the procedure by which a financial service provider verifies the identity of a client. The primary purpose is to reduce risks related to financial crimes, such as money laundering, terrorist financing, and fraud.

In practice, KYC involves collecting personal information (e.g. name, address, date of birth, ID documents) and confirming that this information is accurate and belongs to the actual user. Techniques can include checking government-issued documents, biometric verifications, and cross-referencing public databases.

While KYC has its roots in traditional finance (e.g. banks), it’s now a critical component in legitimizing the crypto space and ensuring compliance with legal frameworks.

Which Crypto Services Are Affected by KYC?

Not all crypto platforms are created equal, whether KYC is needed depends primarily on jurisdiction and transaction volume. But many of the following types of services often require KYC:

• Cryptocurrency exchanges (centralized)
• Custodial wallet providers
• Peer-to-peer (P2P) marketplaces
• OTC (over-the-counter) desks
• Lending platforms (crypto collateral)
• Payment processors accepting crypto
• Token sale platforms / ICOs / IEOs

Key Factors

1. Regulatory jurisdiction
   Many countries legally mandate KYC for crypto firms. In the U.S., for instance, crypto exchanges must register with FinCEN under the Bank Secrecy Act and enforce user identity verification. In the European Union, crypto businesses are classified as “mandatory entities” under the 5th Anti-Money Laundering Directive (AMLD5), with further reinforcement from AMLD6 and forthcoming regulations like MiCA.
2. Volume of operations
   A smaller operation or one handling minimal transactions might delay intensive verification. Some platforms allow basic usage (e.g. small trades, deposits) without full KYC, but enforce full identity checks once thresholds are reached (for withdrawals, large trades, etc.). For example, some exchanges permit limited trading without verification, but restrict withdrawals until a user completes KYC.

Because regulatory demands and thresholds differ by region, there’s no universal KYC rule. Crypto companies must tailor their approach based on where they operate and the scale of their business.

Is It Possible to Operate Without KYC?

In some decentralized or peer-to-peer models, KYC may not be strictly enforced. However, most large exchanges and services eventually require it. When Binance introduced mandatory KYC, over 96% of its existing users complied. In contrast, when a prominent non-KYC platform shifted to KYC, it lost up to 95% of its user base, a stark warning about user resistance.

KYC has its pros and cons:

• Pros: Enhances security, builds trust, reduces fraud, helps regulatory acceptance.
• Cons: Some crypto purists view it as intrusive and antithetical to the ethos of decentralization and privacy.

A nuanced approach is often required: for instance, centralized exchanges (CEXs) typically require full KYC, whereas decentralized exchanges (DEXs) may offer more anonymity, trading purely via smart contracts without user identity checks.

How Does KYC Work in Crypto?

Though implementations vary, crypto KYC usually follows three broad steps:

1. Data collection
   Users submit personal information: their full name, date of birth, address, and a government-issued ID. Some systems automate data extraction (e.g. OCR) to reduce friction.
2. Identity verification
   This step confirms that the ID is genuine and the user is its rightful owner. It might include:
   • Document verification (checking security features, MRZ codes, issuing authority)
   • Biometric matching (face recognition, liveness detection)
   • Cross-checks against public or private databases
3. Due diligence & risk assessment
   If inconsistencies, red flags, or large transaction volumes are detected, further checks may be required (sometimes called KYC 2). This may involve manual review, public records checks, sanctions screening, and proof of address (e.g. utility bills, bank statements).

Once verified, access to full platform functions (trading, withdrawal, etc.) is granted. Afterward, ongoing monitoring is essential, tracking account behavior, flagging suspicious activity, and periodically re-validating user data.

Implementing KYC in a Crypto Platform

You have two main paths when integrating KYC:

1. Use a third-party provider
   Many vendors offer ready-made KYC/identity verification modules you can plug into your platform. This reduces development overhead and ensures you’re using battle-tested systems.
2. Build in-house
   You may prefer full control by constructing your own system using document verification libraries, biometric SDKs, risk engines, database connectors, etc. However, this can be resource-intensive and carries higher compliance risk.

If you opt for a third-party, select a vendor with a solid reputation, global document coverage, and robust verification algorithms. If you go in-house, ensure you stay current on security, regulatory requirements, and technology updates.