Know Your Client (KYC)

Know Your Client (KYC): Essentials for Financial Services and Crypto

What KYC Is
Know Your Client (KYC) is a set of policies and procedures used by financial firms to verify customer identities, understand the nature of customer relationships, and assess risk. KYC is a core element of anti-money laundering (AML) programs and helps firms detect and prevent fraud, money laundering, terrorist financing, and other illicit activity.

Key takeaways
* KYC verifies who a customer is and evaluates their risk profile before and during the business relationship.
* Main KYC components: Customer Identification Program (CIP), Customer Due Diligence (CDD), and Enhanced Due Diligence (EDD) for higher‑risk customers.
* KYC is enforced through regulatory frameworks (e.g., FINRA rules for broker‑dealers, FinCEN guidance for financial institutions).
* Cryptocurrency platforms that act as money services businesses (MSBs) are increasingly subject to KYC/AML requirements, though decentralized services pose enforcement challenges.

Core components
* Customer Identification Program (CIP)
* Collect basic identity information such as full name, date of birth, residential address, and government ID number.
* Verify identity with acceptable documents (e.g., passport, driver’s license) or electronic verification tools.
* Customer Due Diligence (CDD)
* Confirm identity and evaluate customer risk based on the type of account, products used, source of funds, and expected activity.
* For businesses, identify and verify beneficial owners.
* Enhanced Due Diligence (EDD)
* Apply to high‑risk customers or relationships (e.g., politically exposed persons, high transaction volumes, cross‑border or opaque ownership).
* Require deeper investigation into source of funds, ongoing monitoring, and higher approval thresholds.

Regulatory framework and obligations
* Broker‑dealers and investment advisers must use reasonable diligence to know and keep records on customer profiles and authorized account actors.
* Recommendations and suitability determinations should be based on an accurate, current customer profile.
* FinCEN and other regulators require institutions to:
* Maintain up‑to‑date customer records.
* Monitor accounts for unusual or suspicious activity.
* File Suspicious Activity Reports (SARs) and other required reports promptly when needed.
* Failure to comply can result in significant penalties (for example, large civil penalties have been levied against cryptocurrency mixers and other entities for AML violations).

KYC in banking and financial services
* Banks and traditional financial institutions are required to identify customers and beneficial owners, document the purpose of relationships, and monitor accounts.
* KYC obligations apply at account opening and continue through periodic reviews and ongoing transaction monitoring.
* Typical documents: government ID(s), proof of address, corporate formation and ownership documents for business accounts.

KYC and cryptocurrency
* Cryptocurrency exchanges and many service providers that convert fiat to crypto are treated as MSBs and are subject to AML/KYC obligations.
* Decentralized services and peer‑to‑peer platforms complicate enforcement because they can limit the ability to identify counterparties.
* Regulators continue to expand guidance and rules to bring virtual asset service providers (VASPs) into existing AML/KYC frameworks.
* Example outcome: enforcement actions and penalties have been imposed where crypto services failed to meet AML/KYC requirements.

Practical steps for compliance
* Establish a risk‑based KYC program aligned with applicable regulations.
* Use reliable identity‑verification methods (document checks, digital ID verification, biometric checks where appropriate).
* Implement transaction monitoring systems and thresholds to detect unusual patterns.
* Maintain accurate records and update customer information periodically or when risk flags appear.
* Train staff on KYC/AML policies, red flags, and reporting procedures.
* Conduct periodic independent reviews of the KYC program and adapt to regulatory changes and emerging risks.

Conclusion
KYC is a foundational element of modern AML compliance: it protects firms and the financial system by confirming who customers are, assessing their risk, and enabling detection of suspicious behavior. As financial services evolve—particularly with digital assets—firms must maintain robust, risk‑based KYC practices and stay current with regulatory expectations.