On January 3rd, 2020, Bitcoin - the world’s first cryptocurrency, celebrated its 11th anniversary. This was the date when the first block of bitcoins were mined. A week later the EU’s 5th AML Directive came into force, which obligated the crypto market and EU participants working in the EU and UK to authenticate users, track transactions and report questionable operations to authorities, bringing crypto in line with traditional banking financial tracking.

On one hand, crypto’s image stood to improve, even though many continue to it associate with illegal activities and fraud. On the other hand, KYC (Know Your Customer) procedures deprived crypto of what legitimate users appreciated - anonymity, while also becoming an obstacle for residents of developing countries who usually lack the requested documentation. Can crypto wear two hats and become a safe alternative to fiat, while at the same time preserving the values ​​that underpin blockchain technology?

Why Change is Required

According to Coinmarketcap, by the end of 2019 there were 2,389 cryptocurrencies and tokens across the world, built upon the Ethereum, EOS, and NEO blockchains. There were also dozens of hard forks, such as that of Litecoin, Bitcoin Cash, and Monero. In addition, there is a whole family of Bitcoins that originated from the main coin, from BTC to the mysterious Bitcoin X with a market capitalization of just $451. However, more than 90 per cent of those cryptos are nothing but scam projects. Indeed, crypto regulations have been introduced in almost all jurisdictions across the world to weed out such fraudulent projects.

According to Statista, the number of blockchain wallets at the end of 2019 reached the 44 million figure.

As we can see, the crypto world is not yet perfect. Few crypto service providers guarantee the legal origin of the cryptocurrency. Anyone can acquire a crypto asset in some kind of an exchange, enter it and get it onto a blockchain, but if the digital coin’s origin is doubtful, you don’t know if the asset is a form of money laundering. After all, last year alone saw an estimated $2.8 billion worth of Bitcoin traced moving from criminals to exchanges.

As stated by KPMG, at least $9.8 billion in digital assets have been stolen since 2017. To keep growing, the cryptocurrency market needs to change how it secures digital assets for the $245 billion industry.

How the Industry Reacts

Crypto entrepreneurs change themselves with the increasing responsibility needs of the industry. For example, in November 2019, the peer-to-peer cryptocurrency exchange LocalBitcoins received a Finnish license. At the request of the European Commission, the company introduced a strict user verification process, and already in January 2020 stopped serving users from 21 “problematic” countries, including Afghanistan, Iraq, Nigeria, Syria, and Pakistan.

Similarly, the financial platform Wirex informed its users in advance that soon it will become necessary for them to go through the KYC procedure, otherwise starting from January 2020, existing users would not be able to do anything within the service. This is the necessary process of market education where the industry learns to distinguish between what is right and what is wrong. As pointed out in the FinExtra report, KYC is not only a matter of inconvenience for crypto services, but more importantly, is also now a matter of reputation. 

It is not surprising that amongst young fintech projects, there are more and more of those that, from the very beginning, choose to do everything by the book and stay on the right side of the law and regulation. If previously, the mandatory passage of KYC negatively affected the company's conversion rate, because you could conduct any operation in another fintech service without identifying yourself and many preferred those easy to get in services, then now with all fintech services starting to require KYC, the situation will be equalized.

However, there are also examples of crypto projects that wouldn’t play by the new rules and have subsequently been closed. Examples include BottlePay, GO.Exchange and XRParrot.

Who will be Affected or Harmed by KYC?

Naturally, rules are needed, but they should not limit the financial freedom of law-abiding users. It is especially the case that KYC should not affect the inhabitants of countries with unstable economies, where cryptocurrency is especially needed as the lack of required documents is pretty evident and is a serious problem for the citizens of affected countries, which are primarily in Latin America.

When everything is anonymous, it is possible to go around the unfair restrictions of local authorities. For example, due to the ongoing economic crisis in the fall of 2019, the Argentinean government limited the purchase of foreign currency to $200 per month. Many residents were able to transfer their savings to crypto in order to save them from hyperinflation. However, if the wallets were attributed, they would have been left completely without money.

Another example is where Swiss fintech firms cannot provide services to Brazilians, because the Swiss Financial Authority FINMA requires official passports in KYC procedures. Passports have a certain degree of security protection, but the Brazilian government issues “simpler” documents. Yet, the demand for crypto assets precisely in this Latin American region remains high.

Who is KYC/AML an Opportunity for?

The EU’s 5th AML Directive came into force in January 2020, just three years after implementing AMLD4, owing to the 2015 Paris terrorist attacks and 2016 Panama Papers leaks. The introduction of AMLD5 attracted institutional investors into the crypto world.

After amending German law in accordance with AMLD5, forty German banks expressed a desire to provide crypto services to their customers. Three years ago, when the crypto ecosystem was growing, PwC created a crypto team to support crypto firms, not only in areas of strategy or fundraising, but also in the day-to-day functions such as crypto accounting, tax and KYC/AML reviews, which is another trend in itself.

Strengthening the regulation of crypto also contributes to the growth of projects that are engaged in fintech security. So, we saw US crypto technology provider Hoyos Integrity featuring biometrics on its cryptocurrency wallet, accessible through its bespoke mobile phone handsets. ChaimAnalisys became the first crypto project to be included in the Forbes Next Billion-Dollar Startups list, and which boasts 250 customers, including the U.S. government, Barclays and Bittrex. Its co-founder is Jonathan Levin, originally from the UK, where he graduated from Oxford, and now lives in New York City.

Today, we are witnessing how the ecosystem of the crypto world is evolving from 1.0 to 2.0. However, while user identification is necessary, it isn’t all that’s needed for the evolution of crypto world to version 2.0. Another component of this process is the Know Your Transaction (KYT) methodology, with which financial services can obtain information about the origin of a particular coin, and more importantly, collecting the entire history of its owners, i.e. the wallets it has been in right from the moment of its issue through to its original mining. This methodology allows crypto services to protect their customers by preventing coins of dubious origin from entering their wallets. This could be anything from coins being part of fraudulent transactions, “mixers” or wallets of users or countries related to sanctions regimes, i.e. wallets located in the DarkNet.

The Future is Near, yet Far

Just as progressive and radically different approaches are breaking the established ways and rendering them obsolete, the process of crypto mass adoption will be long, full of mistakes, occasional failures, and slow progress. Yet it’s important to understand all the constituents and progressive measures for achieving this, and see the small but successful measures already having taken place around the world. First and foremost, it is the regulation, along with other important steps, that are moving things forward. Removing the key barriers and opening up the convenience, safety, legality and reliability of cryptocurrency to any user is the key goal towards crypto 2.0 age, and this is finally happening.