KYC

Are non-KYC crypto exchanges as safe as their KYC-compliant peers?

While most crypto exchanges have begun implementing KYC mandates, investors still have the choice to opt for crypto exchanges that promote greater anonymity by not imposing KYC.

Many see implementing Know Your Customer (KYC) tools in crypto as a deterrent to the Bitcoin (BTC) Standard, which has predominantly promoted anonymized peer-to-peer transactions. However, regulators stay put on promoting KYC and Anti-Money Laundering (AML) implementations as a means to ensure investors’ safety and protection against financial fraud. 

While most crypto exchanges have begun implementing regulatory recommendations to remain at the forefront of crypto’s mainstream adoption, investors still have the choice to opt for crypto exchanges that promote greater anonymity by not imposing KYC processes. But, does opting for the latter as an investor mean compromising on safety?

A matter of trust

Anonymity goes both ways in most cases. Owners of crypto exchanges running non-KYC (or non-compliant) operations often choose to remain anonymous to avoid legal scrutiny. As a result, investors must have a high level of trust in the people responsible for running the exchange.

On the other hand, decentralized exchanges such as dYdX use trustless protocols for establishing a community-controlled trading platform. This, in turn, instills trust within investors despite no mandate of KYC on the platform.

Therefore, monitoring the platform’s track record and the people running it becomes paramount when trading on non-KYC platforms.

Blockchain remembers forever

While the suits backing traditional finance portray crypto as tools of money laundering, illicit cryptocurrency transactions have consistently declined year-over-year. Despite the ease of using cryptocurrencies without KYC verification, a Chainalysis study confirmed that only 0.15% of all crypto transactions in 2021 were linked to illicit activities.

Moreover, immutable blockchain records allow authorities to retrace owners of the transactions, further deterring bad actors from using crypto — both KYC and non-KYC platforms — to fund their practices.

The permanent nature of blockchain has allowed authorities across the world to hunt down scammers, fraudsters and launderers of crimes they committed years ago.

Not your keys, not your coins

One of the biggest concerns when operating with crypto exchanges is the lack of control over the assets. Cryptocurrencies stored over crypto exchanges mean handing over the private keys to the exchange.

Using unvetted crypto exchanges that market no KYC requirements exposes investors to the risks of permanently losing their funds. While both types of exchanges — compliant and non-compliant to KYC — require investors to hand over their crypto assets to third parties, KYC-compliant exchanges instill greater trust among investors and regulators.

The answer to the question “Are non-KYC crypto exchanges safe?” lies in understanding the abovementioned nuances. KYC or not, crypto investors remain equally vulnerable to the risks related to external factors such as the intent of the owner and shady business practices, in addition to getting no backing from the government.

Additionally, investing with a non-KYC crypto exchange comes with limitations on the trading value, available tokens and other services offered by the provider.

AML and KYC: A catalyst for mainstream crypto adoption

One of the quickest ways to ensure crypto’s mainstream adoption is by working with the regulators, which includes implementing effective and investor-centric KYC and AML tools.

For Satoshi Nakamoto, the creator of Bitcoin (BTC), the motivation to create a new payment ecosystem from scratch in 2009 stemmed from the economic chaos caused by the banking sector’s over-exuberant and risky lending practices mixed accompanied by the bursting of the housing bubbles in many countries at the time. 

“And who do you think picked up the pieces after the fallout? The taxpayer, of course,” said Durgham Mushtaha, business development manager of blockchain analytics firm Coinfirm, in an exclusive interview with Cointelegraph.

Satoshi recognized the need for a new monetary system based on equity and fairness — a system that gives back power into the hands of the people. A trustless system with anonymous participants, transacting peer-to-peer and without the need of a central entity.

Snippet from the Bitcoin whitepaper. Source: bitcoin.org

However, a subsequent market downturn — fueled by the initial coin offering bubble bursting — made the crypto industry realize the need to build credibility, authority and trust by proactively working with regulators and legislators. Enter Anti-Money Laundering (AML) and Know Your Customers (KYC) procedures.

Mushtaha started the discussion by highlighting how, unlike fiat currency, transactions in coins and tokens built on blockchain technology are far easier to trace using on-chain analytics and AML tools. Furthermore, introducing KYC procedures to identify and legitimize users across major crypto exchanges resulted in a far more robust financial system that became more impervious to money laundering and other illicit activity.

As a result, it effectively bolstered the sector’s image and enticed more people to trust their hard-earned money in the market. “I see the next bull market becoming a watershed moment, where the masses dive into crypto as fears dissipate and the sector grows exponentially,” he said.

Impact of KYC and AML on the evolution of finance

The early discussions and implementation of global AML and KYC legislation date back five decades, marked by the establishment of the Bank Secrecy Act (BSA) in 1970 and the global Financial Action Task Force (FATF) in 1989. “The risk scenario indicators developed in traditional finance over the past 50 years have been adopted into crypto and niche sectors of the industry, including decentralized finance,” added Mushtaha:

“Where we differ from traditional finance is our on-chain analytical processes. There are no blockchains in traditional finance, so they are missing a huge part of the jigsaw as the blockchain sector is not siloed.” 

Sharing insights into what today’s KYC and AML implementation looks like from a provider perspective, Mushtaha revealed that Coinfirm has over 350 risk scenario indicators that cover money laundering, financing of terrorism, sanctions, drug trade, ransomware, scams, investment fraud and more. 

With AML getting more sophisticated in the decentralized finance (DeFi) space, “We can now tell you whether your wallet was directly implicated in illicit activities or has inherited risk from another address by receiving assets from ill-gotten gains.” In addition, technology has evolved alongside the crypto ecosystem to provide risk profiles on wallet addresses and transactions based on on-chain analytics.

Declining use of cryptocurrencies in money laundering

Year after year, numerous reports have confirmed a consistent decline in the use of money laundering — with transactions involving illicit addresses representing just 0.15% of cryptocurrency transaction volume in 2021. Mushtaha believes that this finding stands to reason. 

“Those involved in illicit activity would be wise to steer clear of blockchain-related assets and stick to the tried and tested dollar. The United States dollar is still the most utilized and preferred currency for money laundering,” he said while adding that, in crypto, once a wallet address has been identified as holding assets that were earned through illegal activity, there’s little the criminal can do.

With present-day regulatory scrutiny ensuring crypto exchanges are KYC compliant, bad actors find it difficult to off-ramp crypto assets into fiat or spend them in open markets. Speaking about the various methods most commonly used to transfer illicit funds, Mushtaha stated:

“Sure, they can try to make use of anonymizing techniques, like mixers, tumblers and privacy coins, but then their assets will be flagged and tainted for using them.”

As cryptocurrencies become more accepted and prevalent globally, criminals will turn to a black market in order to sell ill-gotten assets. Given the availability of marketplaces where money can be spent without KYC, it will be incumbent on future law enforcement agencies to crack down on such sites.

KYC and AML tools can now correlate IP addresses with wallet addresses, and clustering algorithms do an amazing job at identifying associated addresses. Such measures would be difficult, even for state-level actors, to launder through exchanges outside their borders. Mushtaha added, “The Office of Foreign Assets Control (OFAC) has lists of identified addresses belonging to sanctioned persons and entities. The assets in those addresses are too hot for anyone to handle.”

Role of CBDCs in countering money laundering

Central bank digital currencies (CBDCs) could offer central banks a level of control never seen in fiat currency. Imagine all of the issues with fiat, like government manipulation and inflation, but now with the power of on-chain analytics. CBDCs will allow more granular scrutiny of users’ spending habits and central banks to freeze holdings, limit them, set expiry dates, automatically tax every transaction or even decide what can and can’t be bought with them. “Every merchant, financial institution and retail customer would also need to comply with KYC, thereby disincentivizing money laundering,” said Mushtaha.

Libra, a permissioned blockchain-based stablecoin launched by Facebook’s parent company Meta, failed to gain traction when it was launched in 2019. Consequently, mainstream conversations around Meta’s crypto initiatives catalyzed numerous governments to try out CBDCs, with China being one the first to launch its CBDC.

Worldwide CBDC initiative overview. Source: atlanticcouncil.org

The possibilities for currency control are not the sole motivations for this wave of government-sponsored innovation. While pointing out that governments no longer follow the gold standard, Mushtaha highlighted present-day inflation as a direct result of federal and central agencies printing money at will.

“The United States printed more dollars than ever existed before. And the result of that is rampant inflation that’s off the charts.” 

Moreover, Mushtaha argued that increasing the interest rates too much, too quickly, would cause a catastrophic cascade of overextended debt-ridden financial institutions to collapse. As a result, CBDCs stand out as a solution for central banks, adding that “For the first time, central banks could destroy money as well as create it.”

Evolution of AML, KYC and technological advancements

Based on his extensive experience in the AML/KYC sector, Mushtaha stated that technology adapts to the evolution of regulations and not the other way round. Startup trading platforms that decide to integrate AML tools have the option to apply for a virtual asset service provider (VASP) and securities licenses. “Becoming compliant means a huge pool of opportunities becomes open to you. Funding in this space is only available to those focusing on compliance.” As a result, AML solution providers find themselves bridging the gap between the crypto world and the compliant financial system.

Mushtaha shared an instance working with a startup that is currently developing a nonfungible token (NFT)-based KYC solution using zero-knowledge Proofs. “The cleverness comes from their recognition that NFTs used for KYC don’t need to solve the double spend problem, so can be disengaged from the blockchain entirely. This then allows for private biometric data to be stored on the NFT and a zk-Proof to be sent to each platform where the individual wants to open an account.”

Although the solution is designed to perform as a centralized entity for storing the NFT information “most likely on a permissioned (publicly inaccessible) chain,” Mushtaha affirms it’s a step in the right direction as NFTs serve KYC use cases over the next decade as digitalization continues to permeate across industry verticals.

In terms of AML, new tools and advancements are coming out every month owing to the accelerated rate of innovation. According to Mushtaha, an in-house tool allows Coinfirm to analyze every wallet address that contributes assets to a smart contract-controlled liquidity pool, adding that “We can provide risk profiles for tens of thousands of addresses at a time.”

AI innovations focusing on algorithmically generated transaction-based user behavior pattern recognition will be a key trend. “The blockchain holds a wealth of behavior-related data, that can be used to analyse money laundering patterns, and then extrapolate risk profiles for wallet addresses that behave in these ways,” explained Mushtaha.

Machine learning tools, which have collected large pools of data sets over the years across the crypto landscape, will also be utilized to predict potential trade outcomes.

Governments monitoring cross-border crypto transactions

The FATF issued its revised guidance in October last year, where they labeled every crypto asset that preserves privacy or that doesn’t involve an intermediary of some kind as high risk. This is not surprising as the FATF’s explicit mandate is to eliminate “any threats to the integrity of the international financial system,” of which it considers cryptocurrencies to be one. Hence, the introduction of the Travel Rule in 2019 requires all VASPs to pass on certain information to the next financial institution in a transaction. 

When the rule gets applied to un-hosted wallet addresses held by private individuals, however, “The FATF seems to be laying the groundwork to apply the Travel Rule to these wallets if peer-to-peer transactions increase in the next few years, potentially imposing on privacy rights,” said Mushtaha.

A more prudent approach, according to Mushtaha, would be to harmonize the mostly fragmented implementation approaches of the existing Travel Rule across jurisdictions, making cross-border transactions more straightforward while also focusing on VASP compliance.

Crypto entrepreneurs’ role in countering money laundering

Given the availability of off-the-shelf AML solutions designed to tailor-fit each VASP’s particular requirements, Mushtaha believes “there really is no excuse anymore” for neglecting compliance. It is also incumbent on VASPs to establish comprehensive educational materials for their users as the world prepares for frictionless mass adoption.

Mushtaha believes that crypto entrepreneurs are in a unique position to help write the next chapter of the global financial system, and they should understand that AML compliance isn’t an impediment to their success — but a catalyst. “Most retail investors want to navigate this space safely, managing their risks while transacting,” he recommended. “And giving these investors peace of mind should be a VASP’s priority.” 

Working toward a regulatory future

KYC and AML are necessary elements of today’s macro economy and are important components of the crypto space. Mushtaha disagrees with the belief that regulations erode anonymity. 

“Regulations will drive mass adoption, but it’s incumbent on the players in this space to proactively put forward the framework for regulation that encourages innovation while disincentivizing illicit activity. There is a need to strike a balance where one can monitor money laundering while maintaining a user’s privacy. These are not mutually exclusive goals; you can have both.” 

And, to investors, Mushtaha advised the age-old adage, “do your own research.”

Indian law enforcement accuses WazirX exchange of aiding in laundering of $130M

India’s Enforcement Directorate, which investigates financial crime, has frozen WazirX bank accounts while it looks at transfers from instant loan companies to international wallets.

India’s Enforcement Directorate (ED), the agency responsible for financial crimes, is looking at cryptocurrency exchanges suspected of processing transactions that sent more than 10 billion rupees, or about $130 million, from firms under investigation to international wallets. At least ten crypto exchanges are allegedly involved, according to an official who spoke to The Economic Times, and bank accounts of exchange WazirX have been frozen, the newspaper reported.

Transactions of up to 1 billion rupees, or $1.3 million, were allegedly made in the names of people with no connections to the money by companies under investigation in a case involving instant loans. Thes companies often had ties to China. Even though Know Your Customer/Anti-Money Laundering (KYC/AML) procedures showed the transactions to be suspicious, no enhanced due diligence was performed and no suspicious transaction reports were filed with the ED, the agency claimed.

Related: Crypto tax deters 83% Indian investors from crypto trading: WazirX report

The ED froze WazirX bank accounts, containing about 647 million rupees or $8.1 million last week, alleging that the exchange had assisted about 16 fintech companies under investigation for money laundering. WazirX released a statement on its blog Tuesday “on behalf of Zanmai Labs Pvt. Ltd,” which, it said, co-operates with WazirX along with Binance, saying that all users are subject to KYC/AML processes and the exchange cooperates fully with law enforcement. “For every transaction, we are able to produce the KYC details of the relevant user,” the blog post said.

The accusations against WazirX have drawn attention to its opaque ownership structure and the role Binance plays in it. Binance CEO Changpeng Zhao (CZ) tweeted Aug. 5 that his company did not complete the acquisition of WazirX announced in 2019. The next day, in an exchange with WazirX cofounder Nischal Shetty, CZ stated, “we asked for transferring of WazirX system source code, deployment, operations, as recently as Feb this year. This was refused by WazirX. Binance do NOT have control on their systems.”

This investigation was not the first time WazirX has been accused of inadequate AML measures. In 2021, WazirX was implicated by the ED in the money laundering of illegal online gambling proceeds, also with a Chinese connection.

BitMEX former executive pleads guilty to violating the Bank Secrecy Act

Gregory Dwyer becomes the last one from the exchange’s management to enter a plea.

Another top executive joins three co-founders of the crypto exchange BitMEX, pleading guilty in the United States District Court for the Southern District of New York. The court case under the headline U.S. v. Hayes et al. goes on for two years, with BitMEX management being indicted for violating the U.S. Bank Secrecy Act. 

According to the Wall Street Journal, on Monday, a one-time head of business development at BitMEX, Gregory Dwyer, admitted his guilt in violating the Bank Secrecy Act in court. As part of a plea deal, Dwyer would pay a $150,000 fine.

As Manhattan Attorney Damian Williams commented on this development:

“Today’s plea reflects that employees with management authority at cryptocurrency exchanges, no less than the founders of such exchanges, cannot willfully disregard their obligations under the Bank Secrecy Act.” 

All the founders that Williams mentions have already pleaded guilty earlier. Former CEO Arthur Hayes and one of the co-founders, Ben Delo, admitted their guilt on Februar 24, 2022, while the third co-founder, Samuel Reed entered a plea two weeks later. 

Hayes was sentenced to two years probation, Delo received 30 months of probation, and Reed is facing up to five years in prison. Reed alone agreed to pay a $10 million fine; the same sum would be jointly paid by Hayes and Delo.

The charges against a trio of BitMEX co-founders and Dwyer were filed in 2020. Prosecutors accused the Seychelles-incorporated exchange of false withdrawal from the U.S. market, as it didn’t try hard enough to stop American users from signing up. In addition, BitMEX had been indicted for operating as a money-laundering platform, lacking the necessary Anti-Money Laundering (AML) and Know Your Customer (KYC) protocols.

First Binance soulbound token BAB targets KYC user credentials

Binance’s new Binance Account Bound token is aimed at many use cases in the decentralized society but will initially only serve as Binance KYC user credentials.

Binance cryptocurrency exchange is moving towards decentralized identity tools by launching its first-ever token designed to certify verified user status on the platform.

Binance on Monday announced the launch of the Binance Account Bound (BAB) token, aiming to address identity issues in the decentralized society (DeSoc).

In contrast to traditional crypto assets like Bitcoin (BTC), the BAB token is exclusively for online identification purposes and belongs to a type of Soulbound Tokens (SBT). Proposed by Ethereum creator Vitalik Buterin, SBTs are non-transferable, non-financialized tokens designed for DeSoc.

According to the announcement by Binance, the ​​BAB token is the first-ever SBT issued on the BNB Smart Chain. The token is aimed at many different use cases in the DeSoc but will initiall serve as Binance Know Your Customer (KYC) user credentials.

The BAB token will specifically be displayed on wallets to indicate the wallet’s owner has passed KYC verification on Binance. The token will function as a Binance identity and can be used by third-party protocols to verify BAB tokens for a variety of purposes, including avoiding bots, airdropping nonfungible tokens, voting and others, Binance said.

“As DeSoc use cases evolve, Binance may issue other types of BAB tokens in the future,” the announcement notes.

The BAB token is introduced as a pilot project and will only be accessible via the Binance mobile app, allowing KYCed Binance users to mint their BAB directly on their Binance wallets.

Binance CEO Changpeng Zhao pointed out that SBTs will play an important role in the way Web3 credentials will work in a DeSoc, stating:

“This will transform how we connect, as blockchain technology will give society greater authority to determine how communities interact based on their credentials or affiliations.”

Related: Major South Korean telecom company plans launch of blockchain wallet for crypto and NFTs

The CEO added that Binance will be collaborating with the community to work on new use cases for the BAB token to “develop this revolutionary vision of decentralized society.”

The new token is launched amid online reports claiming that the Binance crypto exchange has lost up to 90% of its customers and billions of dollars after adopting obligatory KYC verification in August 2021. Binance did not immediately respond to Cointelegraph’s request for comment.

Report urges central banks to work together on digital currency interoperability

The Bank for International Settlements, the International Monetary Fund and the World Bank say CBDCs should be programmed in advance to avoid interoperability issues.

International agencies are urging central banks to consider interoperability early in the design of central bank digital currencies (CBDCs). The Bank for International Settlements (BIS) Committee on Payments and Market Infrastructures, the BIS Innovation Hub, the International Monetary Fund and the World Bank released a report Monday that looked at three options for cross-border interoperability that address challenges including high costs, low speed, limited accessibility and thelack of transparency.

The present publication was a response to a 2020 Committee on Payments and Market Infrastructures report that identified 19 building blocks to enhance cross-border payments. Most work on CBDCs has been focused on domestic policy goals so far, according to the authors. They went on to examine variables such as accessibility by payment service providers (PSPs) and nonresidents to wholesale and retail CBDCs and interaction with non-CBDC infrastructure.

Three approaches to interoperability were examined. Compatibility, or the adoption of common standards, would make it easier for PSPs to operate across systems. Interlinking would allow participants in the system to establish contractual agreements, technical links, standards and operational components to perform transactions across systems. Interlinking could be achieved through several models. Finally, a single technical system could host multiple CBDCs.

Related: Crypto resonates better with BIS’ vision of ideal monetary system

International collaboration on CBDC design is necessary to overcome cross-border payment challenges, and many CBDC design features remain undecided in the numerous CBDC projects currently underway. Research is moving fast, so the opportunity for coordination should be seized while it remains, the report said. Coordinating design features could help CBDCs avoid unforeseen pitfalls and improve common Know Your Customer/Anti-Money Laundering efforts. The three approaches to interoperability discussed in the report are not mutually exclusive, although they all involve tradeoffs, the report noted.

Edge announces confidential no-KYC digital currency Mastercard

The company said there will be a $1,000 daily spending limit, but no personal information is required.

On Wednesday, self-custody crypto exchange Edge announced a no-Know Your Customer (KYC) debit Mastercard that can be funded with Bitcoin and other digital currencies.

Without KYC verification, users would be able to spend their crypto at more than 10 million merchant terminals in the United States. Currently, one can fund the Edge Mastercard using Bitcoin (BTC), Bitcoin Cash (BCH), Dogecoin (DOGE), Litecoin (LTC) and Dash (DASH) directly from the Edge app.

In a statement to Cointelegraph, representatives at Edge say that the card is compliant with Anti-Money Laundering and Counter-Terrorism Financing regulations because of a $1,000 daily spending limit on the card (approx. $30,000 monthly). In addition, the card is only available for use at U.S. merchant terminals. Paul Puey, a co-founder of Edge, commented:

“Without compromising any personal info, and without the usual fees or delays to top up their card, the Edge Mastercard is a true breakthrough for using crypto for day-to-day payments.”

Because there is no address associated with the card, users can simply enter any name and address for billing purposes when shopping online.

In addition to its confidentiality, Edge claimed that there are no fees charged on its new Mastercard. When users sell their BTC to add funds, the company uses spot exchange rates from third-party sites such as Coinmarketcap with no margin taken.

The Edge Mastercard will be issued by Patriot Bank, N.A., under license by Mastercard International, and powered by fintech company Ionia. Edge says that it has over 1.7 million accounts across 179 countries on its self-custody cryptocurrency trading platform.