You might be aware of the rising cases of fraud in the world of cryptocurrency – it's probably at its peak. But protecting your business and staying AML compliant with the help of KYC can cost you money. Fortunately, you can make this more cost-effective with digital footprint analysis. Read on to find out how this works.
KYC and cryptocurrency
Crypto businesses (including exchanges) are becoming an increasing target of cybercriminals. According to the Federal Trade Commission, over $1 billion has already been lost by consumers since the start of 2021. The Commission attributes this partly to the decentralized nature of some types of cryptocurrency exchange – once you've lost your money, you can't reverse that transaction. Centralized transactions provide an answer to this, as you can reverse transactions. However, it also means not having your own private keys (meaning that you don't have complete control over your wallet). You're essentially storing and trusting your coins with the third-party exchange.
A lack of a central authority – while being a significant draw to many traders – can prove to be a double-edged sword when it comes to potentially fall victim to fraud, as there's nobody to flag or prevent suspected transactions. Coindesk explains in their own guide to KYC that more crypto exchanges like Binance are having to turn to KYC to stay compliant with increasing restrictions from regulators (but these rules don't apply to decentralized exchanges (DEXs).
Most crypto exchanges, however, have to follow Anti-Money Laundering (AML) regulations like financial institutions and banks as they act as intermediaries, with Know Your Customer (KYC) being the first due diligence stage of this process. This means that most crypto exchanges aren't strictly wholly anonymous – this might go against the original ethos of crypto trading, but regulations help make transactions more secure. The KYC process involves gathering more information on your customer so you can find out whether they carry any potential AML risks, confirm their identity, and whether they are legally entitled to use an exchange. But how does it work, and what's the catch?
Know Your Customer helps you to verify customers upon registration, which can take the form of ID, biometric analysis, and document verification. This helps ecommerce and financial institutions to do digital onboarding more smoothly. Often, criminals will use a synthetic identity (created from information gathered from several victims), which they can't easily verify using documentation. This process can involve checking to ensure that your new customer isn't on any databases for Politically Exposed Persons or sanctioned individuals – this will also show you whether your customer is more likely to commit fraud or any criminal behavior.
All of this information goes towards building a picture of your customer that can help you make better-informed decisions about how to proceed with them. If you think that they are at a high risk of taking fraudulent actions on your site, you can ban them or make it so that users have to present even more information to pass the verification check.
However, the problem here is that the KYC process can be costly – as a recent study by Celent found, KYC-related spending is on the rise (with them predicting it to reach $10.7 billion globally in 2021). Many KYC options currently on the market involve paying per verification, meaning that if you deal with bulk verifications, this can eventually become costly. In a nutshell, the more users you verify, the more you'll have to pay out. KYC can increase churn too: Qualtrics explain that customer wait time is an essential part of any financial institution offering when it comes to customer centricity. That being said, it's usually the case that your marketplace will have to have some form of KYC in place to stay compliant with regulations. However, there are ways of weeding out fraudsters before they even have a chance to reach this stage, saving you precious money and time.
Pre-KYC digital footprint analysis (and how it can save you money during KYC)
One robust solution is digital footprint analysis, which you can employ before the KYC process to weed out fraudsters when taking actions on your site or registering. But can you use digital footprint analysis in place of KYC? Not really. Regarding most crypto exchanges, you can't replace the KYC process (and so comply with any KYC and AML regulations in your country). As explained by SEON, digital footprint analysis means that you can block “pre-junk users before performing expensive KYC checks."
Digital footprint analysis begins with gathering data from a pool of information like their IP address, phone number, email address, and what browser they're using to access your site and their device. The analysis involves enriching a user's primary data sources by merging this with other data points available in databases – for instance, by enriching a user's phone number, you can find out whether it's a fake number, disposable (which cybercriminals are more likely to use), or if it's registered with any messaging apps. Or, you could enrich their email address to find out whether they have any social media accounts linked to that address.
Usually, cybercriminals do not have a solid digital footprint. Perhaps they don't have social media accounts linked to their phone number or email address (or their social media accounts aren't old). Most genuine customers will have a social media presence linked to their phone number or email address and usually have some years-old accounts.
You can then require a user to provide even more additional information to prove they're not a criminal or even block them from your site entirely if you consider them to be particularly high-risk. Some digital footprint analysis feeds into a risk scoring system, which can help show you how high-risk a user is and whether they pose any threat at all. This means that you have fewer users to verify, and it's much more likely that the ones you will be verifying aren't criminals because they're already passed your digital footprint analysis process.
Another plus side of digital footprint analysis is that fraudsters are becoming increasingly innovative in evading KYC verification – tricking biometric verification, for example, using forged documents or mules recruited for the task – meaning that you will only sometimes catch them through this process. Digital footprint analysis can help you to spot suspicious patterns and other activity before you even have a chance to get to this stage.
To sum it up
It's essential to have a KYC process in place as the first plan of action if you want to stay AML-compliant as a crypto business. What's more, having a KYC process in place helps you to weed out fraudsters before they have a chance to take advantage of your business. That being said, it's expensive as every check costs you money; you can cut back on costs by introducing a pre-KYC check known as digital footprint analysis to catch any apparent criminals via suspicious patterns or actions on your site. Enriching a customer's IP address, email, or phone number, for example, with extra information gathered from databases can provide you with more information to make a better-informed decision about a user – and their risk to you.