KYC and KYT Explained: Safeguarding Crypto Platforms

With the rapid expansion of the cryptocurrency industry, maintaining trust and security requires businesses and users to focus on regulatory compliance as a top priority. Know Your Customer (KYC) and Know Your Transaction (KYT) are two key pillars of the crypto compliance ecosystem. KYC verifies user identities, while KYT monitors transaction activities to prevent illicit activities. For businesses, implementing robust KYC and KYT practices using DeFi development services is crucial to ensure compliance, mitigate risks, and maintain the integrity of their platforms.

This blog explores how KYC and KYT function in the crypto space and their synergy. It also highlights the advantages they bring to businesses navigating the complex regulatory landscape of the crypto world.

Explore | Blockchain for KYC | A Solution to Eradicating Inefficiencies

What is KYC in Crypto Compliance

KYC, or Know Your Customer, originates from financial regulations designed to identify and prevent criminal activities. Its foundation dates back to the U.S. Bank Secrecy Act of 1970, which mandated financial institutions to maintain detailed records for detecting and curbing money laundering and fraud. This legislation marked a pivotal moment in the evolution of KYC protocols. Another significant influence on KYC comes from the Financial Action Task Force (FATF) recommendations. These globally recognized guidelines set the standard for anti-money laundering (AML) and counter-terrorist financing (CTF).  FATF specifically emphasizes monitoring crypto asset activities and ensuring compliance among their service providers, providing a framework for robust regulatory practices.

Know Your Customer (KYC) is a process through which cryptocurrency platforms (such as exchanges, wallet providers, and other virtual asset service providers or VASPs)  verify the identity of their users to ensure they are legitimate and not engaging in illicit activities. KYC is a requirement mandated by global regulations, including Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) laws.

The anonymous and decentralized nature of cryptocurrencies makes them attractive to fraudsters for activities like money laundering and other illegal purposes. KYC plays a crucial role here by helping virtual asset service providers (VASPs) verify the identities of their users. This not only prevents misuse but also maintains the integrity and credibility of the crypto ecosystem.

Also, Read | Solving the Issues of the Current Centralized System of KYC with Blockchain

How Does KYC Work in Crypto?

Here's how KYC works in crypto:

User Registration

The process starts when a user registers on a cryptocurrency platform like an exchange, wallet provider, or DeFi protocol requiring KYC. Users must provide personal information such as:

• Name
• Date of Birth
• Email Address
• Phone Number

Identity Verification

To confirm the user's identity, the platform requires official identification documents. These commonly include:

• Government-issued ID (e.g., passport, driver's license)
• Proof of address (e.g., utility bills, bank statements)
• Selfie verification (to match with ID)

Platforms often use AI-powered tools or third-party KYC service providers to automate this verification step.

Document Authentication

The submitted documents are authenticated for legitimacy. This involves:

• Checking for forgery or tampering
• Validating the ID number against government databases
• Verifying that the selfie matches the photo ID

Risk Assessment

Platforms often perform a risk assessment to ensure users aren't flagged in a financial crime or sanction lists. They may check:

• Anti-Money Laundering (AML) databases
• Politically Exposed Person (PEP) lists
• Sanction databases (e.g., OFAC)

Approval or Rejection

Once verification is complete, the platform either approves the user for access or rejects the application if inconsistencies or fraudulent activity are detected.

Also, Read | Is Blockchain the Right Underlying Technology for Digital KYC verification

What is KYT in Crypto Compliance

At some point, it became evident that focusing solely on verifying the identities of the parties involved was insufficient.

While KYC primarily emphasizes confirming customer identities at the beginning of a business relationship, its scope becomes limited after this initial verification. It offers little visibility into ongoing activities, leaving room for deviations from typical transaction patterns to go undetected over time. This is where the Know Your Transaction (KYT) approach introduces a new dimension to financial oversight. KYT shifts the focus to understanding the nature and intent of transactions. 

Know Your Transaction (KYT) complements Know Your Customer (KYC) by focusing on the continuous monitoring of transactions for any unusual or suspicious activity. While KYC is a one-time process that verifies the identity of users, KYT is an ongoing procedure that ensures the legitimacy of transactions in real-time.

How Does KYT Work in Crypto?

KYT (Know Your Transaction) is a crucial tool used by crypto exchanges, financial institutions, and other companies to detect suspicious activities and prevent fraud. Here's how it works:

Transaction Monitoring

KYT systems track transactions, identifying unusual behavior like large or frequent transfers that may indicate fraud.

Risk Scoring

Each transaction is given a risk score based on factors like the amount and destination. High-risk transactions are flagged for further review.

Real-Time Alerts

KYT automatically triggers alerts when transactions meet specific risk criteria, allowing quick action to prevent potential fraud.

In crypto, KYT helps ensure the legitimacy of transactions in real-time, reducing the risk of illegal activities on the platform.

Also Read | Blockchain and KYC: The Next Disruptive Step in Decentralization

Why KYC and KYT Must Work Together

While KYC and KYT serve distinct purposes, they achieve maximum effectiveness when implemented together. KYC verifies user identities at the outset and ensures only legitimate users interact with the platform. KYT maintains continuous oversight of user activities after onboarding. KYT monitors transaction behaviors in real-time to detect fraudulent activities, such as money laundering or illegal funding, before they cause harm.

KYC and KYT together build a robust compliance framework that protects platforms, users, and the crypto ecosystem. KYC confirms the legitimacy of users, while KYT ensures the legitimacy of transactions.

Also, Read | Digitizing AML/KYC Compliance with Blockchain

Business Benefits of Implementing KYC and KYT

Implementing both KYC and KYT processes brings numerous benefits to businesses in the crypto space:

Regulatory Compliance

Both KYC and KYT are necessary to comply with international anti-money laundering (AML) and counter-terrorism financing (CTF) laws. This helps crypto businesses avoid penalties and maintain their licenses to operate.

Fraud Prevention

With KYC and KYT, businesses can minimize the risk of fraud by identifying illicit actors during user onboarding and detecting suspicious transactions in real-time.

Enhanced Trust

By demonstrating a commitment to compliance and security, businesses can build trust with users and investors. This trust is essential for long-term success and reputation in the competitive crypto market.

Better Risk Management

Combining KYC and KYT provides a comprehensive approach to risk management. KYC helps mitigate the risk of onboarding bad actors, while KYT enables businesses to manage risks as they arise in real-time.

The Future of KYC and KYT in the Crypto Space

The growth of the cryptocurrency industry demands increasingly sophisticated compliance systems like KYC and KYT. Businesses are adopting advanced AI-driven technologies to enhance identity verification and transaction monitoring, ensuring robust security while delivering a seamless user experience. Incorporating blockchain into KYC and KYT processes is improving transparency and making these systems tamper-resistant, further strengthening their effectiveness.

The global push for stricter crypto regulations is prompting businesses to implement more rigorous compliance measures. KYC and KYT are taking center stage in this shift, providing the tools necessary to ensure compliance, detect fraud, and maintain the integrity of the crypto ecosystem as regulatory frameworks evolve.

Also, Explore | The Rise of Crypto Derivatives Exchange Development

Conclusion

KYC and KYT are essential components of the crypto compliance ecosystem. While KYC ensures that only legitimate users interact with crypto platforms, KYT provides the ongoing monitoring necessary to prevent illicit activities in real time. Together, they create a comprehensive approach to crypto compliance, enabling businesses to protect their platforms, users, and the broader blockchain ecosystem.

Looking to develop a regulatory-compliant crypto solution? Let Oodles Blockchain handle the complexities of development while you focus on your vision. Our team of crypto developers ensures your project meets all compliance standards and stays ahead of the regulatory curve. Check out this article to explore the challenges of navigating the crypto regulatory landscape, and discover how we make it easier for you!