Navigating the Legal Maze of Cryptocurrency: Understanding KYC Rules, AML Directives and General Bans

The fundamental aspects of cryptocurrency regulation primarily focus on three key areas: prohibition, Know Your Customer (KYC), and Anti-Money Laundering (AML) (Grauer, K., & Jardine, E., 2023).

Know Your Customer (KYC)

Know Your Customer is a standard designed to ensure that Virtual Asset Service Providers (VASPs) implement measures to verify a customer's identity and financial profile. The three key components of KYC are the Customer Identification Program (CIP), Customer Due Diligence (CDD), and Enhanced Due Diligence (EDD) (Chen, J., 2023).

• Customer Identification Program (CIP): Mandates that financial firms acquire four pieces of identification information about a client, including their name, date of birth, address, and identification number.

• Customer Due Diligence: Involves the process of collecting all of a customer's credentials to verify their identity and assess their risk profile for suspicious account activity.

• Enhanced Due Diligence: Applied to customers deemed at high risk of involvement in infiltration, terrorism financing, or money laundering, requiring additional information collection to enhance due diligence (Chen, J., 2023).

Figure 1: Example of KYC application in an app (Kereibayev, O., & Bonda, J., 2023).

Anti-Money Laundering (AML)

While cryptocurrencies are widely known for their use in money laundering, a paper by Vandezande, N. (2017) analyses the evolution of anti-money laundering directives over the years, revealing a historical absence of specific mentions of regulations for cryptocurrencies. The first Anti-Money Laundering Directive in 1991 initially focused on credit institutions’ obligations related to money laundering in drug-related crimes. Subsequently, directives in 2001 (The Second Anti-Money Laundering Directive) and 2005 (The Third Anti-Money Laundering Directive) expanded the framework to address money laundering in other crimes and professions, introducing stricter customer rules and a risk-based approach. In 2013, the proposal for the Fourth Anti-Money Laundering Directive did not explicitly reference virtual currencies. The European Banking Authority (EBA) advocated for including virtual currencies, such as cryptocurrencies, within existing frameworks. Although the Council’s common position in April 2015 did not explicitly cover virtual currencies, it acknowledged the need to combat new and innovative money laundering methods.

The Fifth Anti-Money Laundering Directive (5AMLD), approved in May 2018 and effective since January 10, 2020, established a definition for virtual currencies. It acknowledged providers involved in exchanging virtual currencies for fiat currencies, as well as custodian wallet providers, as entities subject to anti-money laundering and counter-terrorism financing requirements (Grauer, K., & Jardine, E., 2023). Notably, as 5AMLD is a directive rather than a law, individual EU Member States are responsible for implementing its provisions.

Restrictions on the utilization of cryptocurrencies

In an analysis conducted by Grauer, K., & Jardine, E. (2023), the researchers sampled 54 countries, most of them located in the European continent. The study compared whether these countries implement Know Your Customer (KYC) requirements, adhere to the Anti-Money Laundering Directive, or have imposed bans on activities associated with cryptocurrencies.

Figures 2, 3, and 4: Tables illustrating the application of bans, KYC rules, and AML directives across 54 sampled countries (Grauer, K., & Jardine, E., 2023, pp. 40-41).

Summarizing the results, it is evident that only 10 out of 54 countries sampled (~16%) have implemented complete bans. Additionally, 18 countries (33%) do not enforce KYC regulations for cryptocurrency exchanges, and 17 countries (34%) lack complementary Anti-Money Laundering (AML) regulations. Notably, Spain stands out as the sole country that does not utilize KYC requirements but does implement AML rules to govern cryptocurrency exchange operations (Grauer, K., & Jardine, E., 2023).

References:

Grauer, K., & Jardine, E. (2023). Cryptocurrencies and drugs: Analysis of cryptocurrency use on darknet markets in the EU and neighboring countries | www.emcdda.europa.eu. https://www.emcdda.europa.eu/drugs-library/cryptocurrencies-and-drugs-analysis-cryptocurrency-use-darknet-markets-eu-and-neighbouring-countries_en

Chen, J. (2023). Know your client (KYC): what it means, compliance requirements. Investopedia. https://www.investopedia.com/terms/k/knowyourclient.asp

Kereibayev, O., & Bonda, J. (2023). Crypto KYC Guide: How virtual assets are

regulated. Sumsub. https://sumsub.com/blog/crypto-kyc-guide/

Vandezande, N. (2017). Virtual currencies under EU anti-money laundering law. Computer

Law & Security Review, 33(3), 341–353. https://doi.org/10.1016/j.clsr.2017.03.011