Why KYC/AML and Regulation is Essential for Crypto’s Development

Mar 6, 2020

This past week, YouHodler hosted an event in Lausanne, Switzerland regarding crypto KYC/AML and how it’s evolution can help us find a balance between business efficiency and compliance. Before jumping into my thoughts on this event, I’d first like to thank the Crypto Valley Association and everyone who attended and presented despite all fears related to travel at this time. Your insights and participation were invaluable and personally, I came away from this with inspiring thoughts. Since it involves all of us at every level of the crypto industry, I’d like to present my personal opinion on the topic and how this represents a strong foundation for the healthy growth of cryptocurrency on a global scale.

I’m not a compliance person. My goal is to find the right balance between growing compliance requirements, new and often uncertain regulation and business efficiency. We’re operational, but we’re still a start-up (basically as all other crypto-companies), so finding this balance is crucial for us. 

I fully understand the irony of some crypto enthusiasts about “f*ck KYC/AML”, “no KYC - no leaks”, and of course I understand regulators who are scared of a new era of money launderers and financial flows going out of control. At the same time, I strongly believe, that the only way to bring crypto to the same level as fiat in terms of the mass adoption is to make this market truly transparent, but without too much-unneeded control, crazy expenses, inadequate moderation, and all types of idiocy (pardon) that sometimes we see at the traditional world.  

Both worlds: crypto and fiat have clear benefits. The only challenge is to correctly interconnect them. The fiat world has clear expertise and a long, detailed track record. The clear benefit of distributed ledger technology (DLT) is in automation. By the nature of blockchain with its transparency, it’s obviously possible to get to the same level of AML quality with fewer efforts (cheaper, faster, with fewer people involved in AML checks, etc).  

Welcome words from YouHodler. 

The cryptocurrency industry has changed massively in two years

My initial thoughts following this event was how far we’ve all come as an industry. Look at the industry 1-2 years ago. On one hand there were “festival-style” events with thousands of fancy early adopters looking for easy money. On the other - regulators warning about mass scams and potential bans on all types of crypto-activities. What do we have now?  Our event itself was a gathering of industry experts who came together for one day of intellectual discussion and innovative brainstorming.  We’re far away from just “crypto-parties” and see more dedicated professional events in the form of a “meeting of the minds.”  This event showed again that all the hype and fabricated nonsense is gone and in its place, is an industry that’s really serious about increasing the reputation of this technology we all know and love. The market and its participants are now serious and engaged. As a result, more reputable organizations are starting to catch on. They are involved and not going away anytime soon. So, I have clear confidence that the financial system and cryptocurrency will forever be intertwined.

Full room of industry professionals.

Why have we made such progress? I believe there are two main reasons behind that. Firstly because of clear benefits of blockchain technology and it’s values for pushing FinTech (and others) forward. Secondly, because the real volumes and number of people involved in the space has increased (which we partially owe to those people who built hype in the 2015 - 2017 “festival season” of crypto). Now, we finally see an important change in the position of regulators. I consider FATF initiatives and recent EU directives as a positive change, not just another complication. These “guidelines” allow more countries to develop local regulations and finally open the doors for DLT. 

Why is KYC/AML such an important discussion in cryptocurrency today?

Most people’s experience with KYC/AML is the inconvenient procedure of taking selfies, verifying ID cards and filling out personal information. It may seem annoying but it has great importance that I can explain with the help of a little history lesson we heard from Jacques Dahan from CipherTrace during the event. 

Jacques Dahan, CipherTrace 

Let’s go back to the 1980s for a second.  If you look back at that era in technology, you’ll see a completely centralized industry. At that time, big companies like IBM ran the entire show. Consumers were essentially slaves to IBM since they had no control over the product and had no real alternatives. Fast forward to today and it’s a much different story. With cloud-based technologies, the internet, and a wide variety of different services and protocols to choose from, we live in a decentralized technological world. The same transition is happening in the financial system as well.

Before we could only rely on banks to store and send our money but the blockchain is changing all of that. Now, we are all our “own personal banks”. We carry around our assets on our phone and make our own transactions for fractions of a dollar. While this new sense of independence is great, it also opens us up to great dangers as well. If we really want to be our “own bank” and be successful like them, then we need to set up some clear regulations that protect ourselves and others. That’s where new rules come in.

If we’d like to use crypto and fiat together we have to follow those rules. I suppose that it’s already almost impossible to open a bank account for an unregulated “grey” crypto company. At least it’s not something easy. That means that crypto-anarchists cannot provide their customers with fiat services. But, again, we don’t see the future of crypto without connections to the traditional fiat world. 

Crypto KYC/AML divides the normal people from the criminals

"Your fiat money is tainted too, but it doesn't make you a bad customer," says SEBA Head Blockchain Advisory Guido Rudolphi at an event. In the early days, the decentralized and anonymous nature of cryptocurrency attracted a certain crowd to this technology. Criminals and money launderers thrived with a lawless technology such as this one. However, if we really want financial freedom, then we must draw a line. We must have a way of dividing the criminals from normal, law-abiding citizens. There must be a clear set of rules establishing good from evil, light from dark. Helping to create this new rulebook is the intergovernmental group called the Financial Action Task Force (FATF).

FATF’s main goal is to fight money laundering, terrorism financing and other threats trying to dismantle the credibility of an international financial system. To do this, FATF is creating a new rule that will hold all Virtual Asset Service Providers (VASP) responsible. The Travel Rule requires any VASP to obtain, hold, and transmit originator and beneficiary information when transferring virtual assets to or from another VASP or obliged entity on behalf of their clients, for any transfer superior or equal to USD 1000.

The Travel Rules was inspired by traditional finance

The Travel Rule is not anything new. It is used in traditional finance systems with the use of SWIFT. It was established back in the 1970s, but the real revolution was not the SWIFT network itself, it was the creation of a standard and this is the main challenge for the industry.

Setting up a network and a standard that all VASP’s cooperate with will be the biggest obstacle we face on the road to regulation. Thankfully, we have a variety of different solutions on the market such as CipherTrace (Trisa), Synga, Shyft, and OpenVasp. These solutions help VASP’s follow standard governance and to provide a ‘contact point’ for the industry and regulators.

Delphine Forma, Lykke Business speaking about Travel Rule

Are there privacy concerns for this increased regulation?

Across all industries, data privacy is a major concern. Unfortunately, with the introduction of these new technologies, it’s becoming easier for our private data to be exposed. YouHodler has always supported all ideas about data privacy and we will continue to do so. That being said, I don’t think going the opposite direction is healthy either. Having complete anonymity and privacy opens up the doors to the black market and will let criminals run free once again.

If we want mass adoption, we must also include a clean, regulated solution as well. I think we can implement these regulations in such a way that we have our private data protected as well as prevent illicit criminal activity. To do this, we simply need to take inspiration from traditional finance and use innovation to improve upon those regulations for crypto KYC/AML. The Travel Rule could be a big step in the right direction but only if it will be implemented correctly. The crypto industry will need some leeway from regulators to find the right technical solutions to the Travel Rule before hard enforcement”, according to Chris Gschwend from MME Legal. But I’m sure having such great minds working on the issue - it will be implemented properly. 

How to find the balance between business efficiency and compliance?

So, if we’d like to get crypto efficiently integrated into the financial system we (market participants or “VASPs”) have to follow rules from both worlds, traditional and new. As for the fraud detection and prevention we have to use the best KYC/AML practices from both worlds:

  • We have to collect all KYC documents from our clients and make the appropriate sanction screenings and all checks from the traditional world;
  • As for crypto, we have to monitor all incoming and outgoing transactions and avoid risky, dark market, etc operations. 

Normal people should not be afraid of all that KYC stuff if companies follow the best standards of data privacy, but business has to take care of the efficiency. It’s easy to get crazy compliance costs that could possibly destroy any business model. For that reason we have to use some internal guidelines or SLAs, like:

  • Online, almost instant, customers onboarding with automated KYC and sanction screening checks (up to 24 hours for complicated cases);
  • To keep compliance costs at the level of 1% (extreme max 10%) from total costs of acquisition. 

Thanks to the market development we’ve got professional dedicated solutions like IdentityMind, Onfido and others for KYC checks and great blockchain analysis tools for crypto-forensics like Elliptic, CipherTrace, Crystal Blockchain, XDLT and others.  I believe that an eventually, “Travel Rule” implementation will be easy with solutions like OpenVASP and TRISA.  

We’re helping to write the rulebook on the future of cryptocurrency.

There is no clear, well defined global rulebook for cryptocurrency just yet. We’re working on it and making great progress. This is why we’re seeing big institutions like Microsoft, IBM, Google, great examples of the first crypto-banks Sygnum and SEBA  and global governments get involved in cryptocurrency. 

Representatives of the amazing CVA Western Chapter Team: Jérôme, Emi and Ilya  :-)

They see that the legal framework is right around the corner and soon, cryptocurrency will be a fully transparent and trustable industry. There are many great minds working countless hours to push this movement forward and I for one am happy to be a part of it.

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