What is KYC and Why do Crypto Custodians Require It?

Crypto custodians play an essential role in the global crypto ecosystem, securely storing digital assets for their customers. Due to the sensitivity of their business, they need to establish strong and secure anti-fraud measures in order to carefully vet their customers, and they are also subject to regulations that require them to carry out robust KYC and AML. This article takes a look at what those responsibilities are — and how they can be realized using Automated KYC.

Crypto custodians are specialized service providers that securely store digital assets on behalf of their customers. Crypto custodians can offer both cold and hot storage solutions, depending on the customer’s security needs. They also provide secure access to those digital assets through a variety of methods such as multi-factor authentication, hardware wallets, and air-gapped systems. 

Crypto custodians play an essential role in the cryptocurrency ecosystem as their services help to protect against cyber security threats and enable safe, secure access to digital assets. 

Crypto custodian services are especially important for businesses within the crypto space as they offer institutional-grade security solutions that meet financial regulations and compliance requirements. 

With increasing government oversight on cryptocurrency transactions, many businesses must now obtain licenses in order to operate legally. By providing reliable storage solutions for these businesses, crypto custodians help ensure that the crypto ecosystem remains compliant with regulations while maintaining a high level of safety and security for investors. 

In addition to their main functions, crypto custodians can also provide independent auditing and reporting services that verify the accuracy of records held by exchanges and other entities operating within the crypto space. For these reasons, crypto custodians play a critical role in  establishing trust among participants in the cryptocurrency markets — an essential component of successful trading and investing activities.

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What is KYC?

Know Your Customer (KYC) rules and checks are essential for financial institutions (FIs)  to ensure that customers have provided accurate and complete information about their identity. KYC checks involve verifying customer identities by confirming personal information such as name, address, proof of identity and source of funds. 

Carrying out effective KYC is a key responsibility for FIs and VASPs to comply with Anti-Money Laundering (AML) regulations and to prevent fraud by detecting suspicious activities such as money laundering or terrorist financing. 

In addition, KYC checks are also used to assess a customer’s risk profile in order to optimize the way a financial institution or virtual asset service provider (VASP) processes them through their AML program – and what kind of services they provide to them. This is known as a Risk-Based Approach, which is highly recommended by global regulatory bodies such as the Financial Action Task Force (FATF)

By collecting comprehensive due diligence data from customers, FIs and VASPs can ensure their clients are not involved in any illegal activities, build trust among their client base and maintain compliance with complex global financial regulations. 

KYC & AML rules for Crypto Custodians

AML and KYC rules and regulations are essential to the crypto custodian industry. Crypto custodians must adhere to certain obligations in order to keep their customers safe from any forms of financial threats, such as illicit activities or criminal operations — and to also ensure that their services are not being exploited by financial criminals for money laundering and other illicit activities, including terrorist financing. 

The FATF is an international intergovernmental organization focused on combating money laundering and terrorism financing. The organization has established specific guidelines for VASPs regarding KYC and AML checks. These guidelines, which fall under a group of “FATF Recommendations”, include various customer due diligence measures, risk-based approaches, and customer identification protocols. For example, VASPs in FATF-compliant countries — the majority of the world’s economies  — must comply with customer identification requirements such as collecting information on their clients’ identity and source of funds. 

Similarly, the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) has set certain rules for VASPs operating within its jurisdictions. Specifically, FinCEN requires VASPs doing business in the US to register with them and also mandates the implementation of AML/KYC measures such as conducting ongoing monitoring of transactions and reporting suspicious activity that could be indicative of money laundering or terrorist financing. 

Additionally, FinCEN requires VASPs such as crypto custodians to maintain adequate records regarding customer onboarding processes and transactions they carry out on behalf of their customers. This helps ensure that they are able to meet their obligations under AML/KYC regulations even if they have no direct contact with their customers. 

Crypto custodians need to conduct KYC checks on their clients in order to meet these and many other global compliance requirements and to protect themselves from financial crime. 

KYC checks help a custodian determine: 

  • The identity of each customer
  • Verify their sources of funds
  • Confirm that they are not associated with any illicit activities 

By carrying out KYC procedures, crypto custodians can ensure that their services are in line with regulations and standards imposed by governmental and regulatory bodies. 

KYC/KYB for Crypto Custodians

KYC typically involves collecting personal information such as name, address, date of birth and government-issued identification numbers. 

In addition, crypto custodians may also require additional forms of verification such as proof of residence or source of funds in order to more robustly prevent money laundering, fraud and other financial crimes. 

To further ensure security, some crypto custodians may also request biometric data such as fingerprints, voice recordings and facial recognition scans from customers. 

By enforcing these AML/KYC regulations for crypto custodians across the financial industry, regulators can help prevent financial crimes by ensuring compliance with proper KYC/AML checks when dealing with virtual assets or fiat currency transfers. This ultimately helps create a more secure environment for customers who use services provided by crypto custodians while also helping protect the integrity of the financial system at large.

Benefits of Automated KYC/KYB for Crypto Custodians

By using Automated KYC systems, crypto custodians can also access additional resources that can be used for further verification and risk management measures. Having access to this data enables them to better monitor transactions, detect suspicious activity, have uniform and consistent track records of their compliance procedures — and reduce exposure to fraudulent activities. 

In addition, KYC documentation allows custodians to have a clear understanding of the customer’s financial background in order to provide appropriate services tailored to their needs. All these factors highlight the importance of requiring customers who use crypto custody services to provide the necessary KYC information before conducting business.

Benefits of Automated KYC include:

  1. Improved accuracy and efficiency of KYC processes
  1. Reduced manual effort and reliance on human compliance teams for processing information 
  1. Increased security through automated identity verification
  1. Ability to quickly onboard customers remotely in diverse jurisdictions
  1. Reduced paperwork and storage costs related to customer data  
  1. Instant alert notifications when suspicious activity is detected 
  1. Easier compliance with global privacy regulations such as GDPR 
  1. Seamless integration with existing systems for a streamlined workflow 

      9. Enhanced customer experience through improved onboarding processes  

  1. Automated fraud detection to mitigate the risk of financial losses due to fraudulent activity 
  1. Consolidation of multiple data sources into a single view 
  1. Improved transparency and traceability for auditing purposes  
  1. Enhanced customer insights through predictive analytics and reporting tools 
  1. Streamlined workflow across multiple business functions such as KYC, AML, onboarding, etc.  
  1. Greater scalability when expanding operations into new markets or regions.


How KYC-Chain can help

KYC-Chain’s end-to-end onboarding solution allows crypto custodians and other VASPs and FIs to efficiently and securely onboard clients, adapting checks according to the regulatory requirements of the global jurisdictions they are found in. This allows our clients to quickly scale into new markets, strengthen their anti-fraud safeguards and reach compliance in the markets they operate in — all through a seamless and customer-centric onboarding journey. 

Are you a crypto custodian looking for an automated KYC solution to take your business to the next level? Get in touch and we’ll be happy to arrange a demo