How do KYC and AML procedures in the crypto world help prevent fraud?

Early November was not an easy time in the Hong Kong office of a global cryptocurrency exchange, FTX. After battling comments from their competitors on social media on November 6, the company halted withdrawals on November 8. Over the next two days, after hearing a vague comment from their colleagues in the Bahamas, employees in Asia were told not to come to the office. This fiasco of FTX management and their implementation of anti-money laundering (AML) procedures has become a hot topic in the community ever since. After months of active encouragement from various global regulators to establish and follow AML and Know Your Customer (KYC) policies, Virtual Asset Service Providers (VASPs) watched FTX continue its operations while it had an $8 billion hole in its balance sheet. An obvious question that would come to mind would be whether getting full transparency is still in vogue. If implementing KYC and AML procedures is still necessary, what could be done better to prevent cases like FTX?

Has the FTX team done its best to review its own AML procedures? FTX could have developed sophisticated AML and KYC policies for the firm, their clients and their counterparties. However, to determine whether employees followed those procedures, an auditor had to talk to stakeholders and review relevant files, systems and documents. Now we can only assume that the top management of the exchange noticed discrepancies in the firm’s records and compliance actions and yet chose to turn a blind eye to such occurrences. Such things would be promptly detected and reported to the relevant auditors and regulators when management and the board are diverse. In the case of FTX, access to information and decision-making power was concentrated in the hands of a very small group who appear to have followed the same moral principles.

AML and KYC policies will continue to come from regulators in all jurisdictions globally. Reuters discussed the need for such initiatives in its September article describing the regulatory environment in the United States. In addition to being a clear trend, AML compliance is beneficial for crypto for several key reasons. First, implementing such policies and tools can provide better transparency and improved auditing for exchanges, custodians and other VASPs. This will subsequently generate greater demand for those platforms as users develop deeper trust. Second, implementing wallet and transaction checks helps avoid locking up assets of certain clients and preventing entry into the ecosystem. With proper verifications, customers can be assured that they will never engage in transactions that would damage the reputation and history of their wallets. And finally, the implementation of AML and KYC tools makes it possible to immediately identify fraudsters and block their funds, increasing the security level of the service many times over.