What is KYC and Why Has It Become a Mandatory Requirement in Financial Transactions Today?

In the context of rapidly developing blockchain technology, financial institutions and cryptocurrency exchanges are all implementing customer identity verification processes. This is considered a foundational step to protect the system and users. So, what exactly is KYC? Why does the financial industry emphasize its importance? This article will help you better understand this identity verification process.

What Are KYC and eKYC?

KYC stands for “Know Your Customer.” It is a mandatory verification step that financial organizations must perform to gather information about their clients.

When performing the KYC process, organizations evaluate customers based on several criteria such as:

• Financial risk tolerance
• Investment and securities knowledge
• Transaction history
• Financial sources

The KYC process not only helps identify customers but also serves as an important tool to combat money laundering (AML) and prevent terrorist financing. Today, KYC is a common compliance requirement at cryptocurrency, forex, and international securities exchanges.

eKYC (electronic Know Your Customer) is the digital version of this process, allowing fully online identity verification. Users do not need to visit an office in person and can complete the entire procedure via an app or website.

Common documents required for KYC include:

• Identity card / Citizen identification
• Passport
• Driver’s license
• Bank statement or financial proof

How Does the KYC / eKYC Process Work?

Step 1: CIP - Customer Identification Program

CIP (Customer Identification Program) is the first stage of the KYC process. At this step, financial organizations collect and verify basic customer information.

With increasing identity theft, data from 2017 shows that in the US, up to $16.8 billion was stolen due to identity security breaches, directly affecting over 17 million people. Therefore, identity verification is an indispensable step.

CIP typically includes:

• Full name
• Date of birth
• Residential address
• Related personal information

Step 2: CDD - Customer Due Diligence

After successfully verifying identity, organizations proceed with CDD (Customer Due Diligence) — a more thorough background check.

This step includes three levels of due diligence:

• SDD (Simplified Due Diligence): For low-risk customers
• CDD (Basic Customer Due Diligence): Standard check for most customers
• EDD (Enhanced Due Diligence): For high-risk customers or large transactions

The purpose of CDD is to assess potential risks, classify customers, and protect them from activities related to terrorism or financial crimes.

Step 3: Continuous Customer Monitoring

KYC is not a one-time process. Financial organizations need to establish ongoing monitoring programs to track:

• Sudden activity spikes compared to previous habits
• Unusual cross-border transactions
• Suspicious payment methods

This allows early detection of risky behaviors and legal issues.

Why Is KYC Important?

Preventing Identity Theft

KYC establishes the legal identity of customers, preventing fake accounts and misuse of personal information. Organizations verify the real identity of users before granting trading accounts.

Anti-Money Laundering (AML)

AML (Anti Money Laundering) is an extension of KYC. While KYC focuses on verifying identity, AML concentrates on monitoring and preventing money laundering activities.

KYC helps prevent criminals from using fake accounts to store funds for:

• Drug trafficking
• Human trafficking
• Smuggling
• Fraudulent activities

Protecting Against Financial Fraud

KYC prevents fraud behaviors such as using fake IDs, identity theft to apply for loans, or withdrawing funds from fake accounts.

Why Do Cryptocurrency Exchanges Need KYC?

In the cryptocurrency field, KYC becomes especially important due to the decentralized nature of these platforms.

In 2021, five major ransomware attacks crippled computer systems until victims paid. In 2020, victims of such malicious activities lost nearly $350 million in cryptocurrency to attackers exploiting DeFi’s anonymity.

By enforcing strict KYC, exchanges can:

• Minimize negative activities
• Improve the image of cryptocurrencies in the economy
• Eliminate links to money laundering and illegal activities
• Encourage wider adoption and investment

Which Organizations Use KYC?

KYC is now a mandatory requirement for:

• Commercial banks
• Credit unions
• Asset management companies
• Brokerage firms
• Fintech and financial technology applications
• Private lending platforms
• Cryptocurrency exchanges

Governments in many countries require financial organizations to implement KYC procedures to enhance security and prevent fraud.

Difference Between KYC and AML

Many people confuse these two concepts. The truth is KYC is just a subset of AML.

• KYC: Focuses on verifying the customer’s identity at the initial stage
• AML: Is a broader management process, including KYC and continuous transaction monitoring

Understanding this difference helps organizations tailor their AML programs to their specific needs.

Conclusion

What is KYC is no longer a new question in the digital finance era. This process has become an essential component to protect users, financial organizations, and the entire economic system.

By applying KYC / eKYC, organizations not only comply with laws but also build trust with customers through better security, reduced fraud, and anti-money laundering efforts. Investors should choose exchanges that implement eKYC to ensure their rights and assets are maximally protected.