Know Your Customer (KYC)

What does Know Your Customer (KYC) mean?

Regulatory requirements for banks and financial institutions to screen and verify the identity of their account holders and customers.

Main Idea:

Traditional financial institutions have the burden of complying with due diligence regulations that are strict, complex, dynamic, and multi-jurisdictional – in order to verify the identity of their customers. The goal is to screen customers and their dealings in order to prevent and identify illegal activity.

The Problem

Know Your Customer (KYC) regulations impose high costs which are passed on to the consumer. In addition, it excludes the billions of people who are too poor to pay or endure the costs, do not have access to financial institutions, are missing identification papers (e.g. refugees and displaced persons), or live in societies that limit their financial activities by virtue of their sex or social status. While these populations are typically grouped under a category called “the unbanked”, they have diverse backgrounds and needs that do not conveniently fit into a common regulatory category.

The costs of KYC regulations lend an advantage to institutions who are better able to handle compliance with the economies of scale of trained personnel and resources, as well as the ability and authority to maintain physical facilities or provide other means to verify customers one on one.

From the client’s side, high costs, limited access, and services that are restricted to an institution’s offerings make “onboarding” a centralized financial institution onerous for those who can afford the process and prohibitive to others.

The issues do not stop at financial onboarding. Exclusion from the financial sector has ripple effects that extend to all areas of life for these people and their families.

Finally, all centralized institutions are trusted data intermediaries (TDIs) that have the power to alter, charge, or reverse your transactions, change their terms of service, and leave your data vulnerable.

A Decentralized Blockchain Solution

As blockchain technology continues to develop the means for secure person-to-person exchanges of services, data, and financial transactions, the hurdles of geography, time, social status and acceptance by central institutions could be surmounted by inexpensive access to a mobile device.

The vision of a low-cost, scalable Decentralized Finance (DeFi) system is certainly that of a more inclusive economy. How countries’ regulatory framework and DeFi will develop together is one of the most pressing issues to settle for finance and blockchain more generally.

Used in a Sentence:

Traditional Know Your Customer (KYC) regulations exclude many (billions) of people from accessing centralized banking and financial services because of issues with identification or inability to pay; the consequences of these policies indicate they should be re-evaluated for their costs and benefits in modern times.

Last Updated: March 3, 2023