When Satoshi Nakamoto wrote in Bitcoin Whitepaper, "The possibility to be anonymous or pseudonymous relies on you not revealing any identifying information about yourself in connection with the bitcoin addresses you use," his message was clear and simple. Bitcoin is designed to protect your financial privacy from centrally controlled institutions. There are no ifs and buts in this, but the things are no longer the same.
As Bitcoin and other cryptocurrencies gained enough attention, they invited not only new investors for P2P trade but also some centralized exchanges which make the process of trading cryptocurrencies much more 'easier' in exchange for small transaction fees. But with time, the government's increased concerns and unfortunate misuse of the emerging tech forced the regulators to implement the Know Your Customers (KYC) policy on crypto exchanges, making it a mandate.
“KYC demands that banks hold up-to-date identification records for every one of their customers, while also maintaining a risk profile for both the client and their relevant country,” World Finance defines KYC.
However, industry experts often criticize the need to have KYC mandates for all crypto transactions due to the fundamental contradiction in monitoring the nature of KYC and pseudo-anonymous crypto transactions.
Andreas Antonopoulos, a British-Greek author and entrepreneur finds KYC in crypto as a fundamental misunderstanding of the technology. Antonopoulos states in his book, The Internet of Money, "The idea that we need to monitor, surveil, and control every transaction to prevent bad actors from using cryptocurrencies is a fundamental misunderstanding of the technology and a compromise of privacy."
While in his different interviews, the renowned digital privacy activist, Edward Snowden has labeled KYC as a dangerous trade-off. Snowden says, "While KYC might offer a veneer of security, it comes at the cost of sacrificing individual privacy. In the digital age, this is a dangerous trade-off."
On one hand, many tech experts find KYC to be nothing but a redundant and futile exercise, Brad Garlinghouse, CEO of Ripple has a different belief. "While privacy is important, ensuring that the crypto ecosystem is free from fraudulent activities requires robust KYC and anti-money laundering (AML) procedures."
Jeremy Allaire, CEO of Circle also finds KYC norms to be foundational to establishing trust in the crypto industry and enabling their broader adoption by institutional investors and regulators.
Following the same lines, Adena Friedman, CEO of Nasdaq, believes that for cryptocurrencies to gain mainstream acceptance, KYC and AML procedures and crucial as they mitigate the risks of money laundering and foster a secure trading environment.
According to Coindesk research, all the anti-money laundering and KYC measures have cost the industry more than all the ICO scammers put together. And the fact is, the total KYC spending rose to up to $1.2 Billion in 2020 on a global level.
According to a 2021 report by Chainalysis, illicit activity represented just 0.34% of all cryptocurrency transaction volume or approximately $10 billion worth of transfers. This figure was down from 2.1% in 2019. While the percentage decreased, the absolute value increased due to the overall growth in the cryptocurrency market.
Here are some of the reasons that underline how KYC measures can compromise the fundamental use cases of cryptocurrencies.
One of the core principles of cryptocurrencies, such as Bitcoin, is pseudonymity. KYC requirements eliminate this anonymity, making it easier to trace and track individual transactions, thereby compromising user privacy.
KYC processes centralize sensitive personal and financial data within exchanges or platforms. This centralization creates a honeypot for hackers, increasing the risk of data breaches and identity theft.
Mandatory KYC procedures can deter individuals from participating in the cryptocurrency ecosystem, especially in regions with strict regulatory requirements or where privacy is a primary concern.
KYC measures introduce a form of centralized control by requiring entities like exchanges to collect and verify user information, thereby contradicting the decentralized ethos.
Implementing KYC can lead to heightened regulatory oversight and compliance burdens for cryptocurrency businesses. This can stifle innovation, deter investment, and limit the development of new technologies within the crypto ecosystem.
Despite all the criticism, it is true that KYC has played its role in taking cryptocurrencies to the common masses and bringing in the trust that has enabled the industry to thrive. Here are some of the reasons why KYC is still a requirement:
Regulatory Compliance: KYC ensures cryptocurrency platforms adhere to legal obligations, helping prevent illicit activities like money laundering and terrorist financing.
Consumer Protection: Implementing KYC measures offers users a level of security by verifying identities, reducing fraud, and enhancing trust within the crypto ecosystem.
Institutional Acceptance: Robust KYC procedures facilitate greater acceptance of cryptocurrencies by traditional financial institutions and regulators, fostering mainstream adoption and investment.
Also Read: India’s Data Privacy Bill and its Impact on Crypto Industry
