Know Your Customer (KYC) is the process of the identification and verification of individuals/legal entities via identifying information, (i.e. legal name/address) & the verification of those details to identify fraudsters, money laundering, terrorist financing, etc.
Know Your Customer requirements differ between banks in different jurisdictions.
Some banks or obliged entities will ask for a Proof of Identity, Selfie and Proof of Address.
There are 3 key components to an effective Know Your Customer system are; Customer Identification Program (CIP), Customer Due Diligence (CDD) and monitoring.
Customer Identification Program (CIP) is the stage of KYC where an obliged entity verifies the customer’s identity correctly – by being provided with an officially-recognized identification document (e.g. passport, driving license), their name, address, country of residence, date of birth.
Customer Due Diligence (CDD), the second part of efficient Know Your Customer, is when a crypto-asset exchange or custodian establishes the risk profile of a new potential client and determines whether the Customer Due Diligence (CDD) relationship warrants either *Simplified Due Diligence (SDD) or **Enhanced Due Diligence (EDD).
*SDD is used when a customer is identified as having a low risk of being involved with money laundering and funding terrorism such as normal/low-value bank accounts.
**EDD is leveraged when a customer is identified as having a higher risk of being involved with money laundering and funding terrorism. Additional compliance requirements are set for EDDs such as transaction monitoring (this enables crypto-asset custodians to chart normal patterns of transactions to then identify potentially risky activity). Whilst EDD is a more expensive Know Your Customer practice to high-risk entities at the outset, deployed correctly, EDD prevents damaging fines, adverse media and even the potential collapse of obliged entities (i.e. large-scale Ponzi schemes, ransomware gangs).
Monitoring is the part of KYC where checks are conducted regularly to determine if the customer’s activities are following their normal behaviour patterns or whether higher-risk activities are being noted (i.e. large transactions in quick succession with the same value leaving the account within a few hours).
KYC is usually the first step in a the compliance journey of a new client relationship.
Know Your Customer is a critical part of the Risk-Based Approach (RBA) to financial crime. Without knowing who a financial institution or obliged entity is doing business with, it is extremely hard to judge risk.
A thorough KYC analysis will inform a Virtual Asset Service Provider (VASP) if, for example, a customer is a foreign or domestic Politically Exposed Person (PEP), the Ultimate Beneficial Owner (UBO) of an entity known to launder illicit funds, is based in a greylisted/blacklisted/sanctioned jurisdiction or is an associate of someone that meets the prior criteria examples.