Customer Identity Verification (KYC) - Why Is It a Vital Factor in Financial Transactions?

In the context of rapidly developing Blockchain technology, customer identity verification has become an essential requirement for all financial institutions. But what is KYC? Why is it so important? To gain a deeper understanding of this issue, this article will analyze in detail the concept, process, and practical significance of KYC in the world of digital transactions.

What Is KYC? Differentiating Between KYC and eKYC

KYC stands for “Know Your Customer” (Understanding the Customer), an important step in the due diligence process that financial service providers must perform. The purpose of KYC is to verify identity, assess financial risk tolerance, and determine the customer’s investment knowledge.

eKYC (electronic Know Your Customer) is the digital version of the above process, fully conducted online without physical documents. This approach helps speed up verification while maintaining high security.

Commonly required documents for KYC include: ID cards, Passports, Driver’s Licenses, Bank Statements, and other identity verification documents.

The Importance of KYC in Financial Transactions

KYC is not just an administrative requirement but a foundational element that protects the entire financial system. Here are the main reasons:

Prevent Identity Theft: KYC establishes the legitimate identity of customers, thereby eliminating the possibility of creating fake accounts. In 2017 in the US, over $16.8 billion was stolen, affecting more than 17 million people, highlighting the severity of this issue.

Anti-Money Laundering (AML): The KYC process helps identify and prevent organized crime groups or individuals using fake accounts to conceal illegal activities such as drug trafficking, human trafficking, or fraud.

Prevent Terrorism Activities: KYC supports the detection of individuals or organizations involved in terrorist financing, safeguarding financial security.

Enhance Cryptocurrency Image: When cryptocurrencies are tightly regulated through KYC, they shed their reputation as tools for money laundering, encouraging wider adoption.

How Do KYC / eKYC Processes Work?

The KYC / eKYC process consists of three main stages:

Stage 1: CIP - Customer Identification Program

CIP (Customer Identification Program) is the initial step, where the organization collects basic information:

• Full name
• Date of birth
• Permanent address
• Other relevant personal details

Stage 2: CDD - Customer Due Diligence

After verifying identity, the organization conducts CDD (Customer Due Diligence) to assess risk. This step is divided into three levels:

• SDD (Simplified Due Diligence): Applied for low-risk customers
• CDD (Basic Customer Due Diligence): Standard check with medium risk level
• EDD (Enhanced Due Diligence): Advanced checks for high-risk cases or public figures

Stage 3: Continuous Monitoring

Financial institutions must establish ongoing customer monitoring programs, overseeing:

• Unusual transaction activities
• Geographical or cross-border movements
• Warning signals related to media or suspicious channels

Difference Between KYC and AML

Many confuse KYC with AML, but they are not the same concept.

AML (Anti Money Laundering) is a broader component—a comprehensive management framework that all financial organizations must have to combat money laundering.

KYC is an indispensable step within AML. It focuses on verifying identity and assessing customer risk, while AML encompasses transaction monitoring, suspicious activity reporting, and legal compliance.

Simply put: KYC is one of the main tools for implementing AML programs.

Who Needs to Perform KYC / eKYC?

Any organization operating in the financial sector must comply with KYC:

• Commercial banks
• Credit cooperatives
• Asset management companies
• Brokerage firms
• Fintech platforms (Fintech)
• Private lenders and lending platforms
• Cryptocurrency exchanges
• Forex and international stock exchanges

Governments are increasingly demanding stricter enforcement of KYC procedures to enhance security and prevent fraud.

Why Do Cryptocurrency Exchanges Need KYC?

Enforcing KYC helps electronic exchanges reduce negative activities. For example, in 2021, five major Ransomware attacks encrypted user computers until ransom was paid. In 2020, victims lost nearly $350 million in cryptocurrency due to attacks supported by anonymity in decentralized (DeFi) systems.

KYC is the key to:

• Protecting customers from attacks and scams
• Building trust in cryptocurrencies within the economy
• Reducing the link between cryptocurrencies and illegal activities
• Facilitating wider adoption of cryptocurrencies

Conclusion

KYC has become an inseparable component of any financial organization’s operations. This process not only protects organizations from legal risks but also safeguards users from fraud, identity theft, and illegal activities.

In today’s digital transaction world, compliance with KYC / eKYC is not optional but a mandatory requirement to ensure safety, security, and legality in all financial dealings. Customers need to understand the importance of this process to participate more confidently in online transactions.