Is KYC A Hindrance To Mass Adoption?

The cryptocurrency market has been subject to a lot of intense examination and discussion by lawmakers in the past two years. For most of the market's life, the market has gone unscathed, only occasionally incurring the wrath of authorities when something particularly egregious happens.

But governments cannot afford to ignore crypto any longer — both from the perspective of its potential and the effects it can have financially and legally. As such, there is a global trend toward regulation, with one of the key focuses being Know-Your-Customer (KYC) checks.

These broad changes are inevitable for the crypto market, but what good and bad effects might they have on the market's future? Here, we discuss whether KYC is good or bad for the crypto market and the broader implications that these new compliance checks will have.

The Effects of KYC

KYC rules exist in the pre-existing financial world for several reasons. It aims to ensure that users of financial services are not operating outside the law and generally clamps down on illicit activity. Banks also use the information to manage their risks and handle customers better. It is a standard process for any financial service, and you, the reader, will have experienced this process yourself.

KYC is accepted in the financial world, but the novel market of cryptocurrencies has a few issues with the procedure. Primarily, cryptocurrencies are inherently supportive of privacy and all-inclusiveness. This is one of the reasons why KYC compliance changes from exchanges are met with such disdain and why it can affect the operations of crypto companies.

An exchange or any other crypto company that is mandated to implement KYC checks can see an outflow of capital and a reduction in user numbers. However, this may just be a short-term effect; as we shall see, KYC may have benefits in the long run.

Many cryptocurrency users deal with the asset class precisely to hide their financial activity and, as such, simply turn to non-custodial wallets, privacy coins and decentralized exchanges to handle their activity. So, it isn't really the case that KYC checks have a significant impact on the user level — it's simply that they must go elsewhere to carry out their trading.

Why KYC Is Good

For all the ruckus that KYC checks seem to have caused, there is actually plenty to be said in favor of KYC for the crypto market. The asset class has long been considered to be a gray area, a wild west, a financial environment operating outside the confines of most laws — which has come with benefits and risks.

KYC mitigates some of those risks. After all, even crypto companies do not wish to be, in any way, a facilitator of illegal financial activity. The implementation of KYC will also raise the credibility of the crypto market in the eyes of both retail and institutional investors. There is a substantial portion of investors out there who are seeking to enter the market but feel that it is not yet safe enough — for various reasons.

With some checks in place, the crypto market can become stronger in investor protection and more moral, and those investors wish for that. The end result is that there will be a greater deal of adoption, which is what the crypto market has always been clamoring for.

It's not dissimilar to all the securities laws and regulations that were imposed since the early to the mid-20th century. These changes are necessary for the crypto market to grow and evolve, and what the market gets out of it is an honest market that appeals to everybody.

Why KYC Might Be Bad

There are some downsides to KYC implementation as well, the most notable one being the exodus of users to decentralized platforms that collect no information whatsoever. The crypto market is a hard one to regulate precisely because it is decentralized in nature. Governments and financial regulators may be able to clamp down on the worst of the activity, but they will find it extremely difficult to truly stamp out all such activity.

The major downside to KYC implementation is that it will result in lower activity for crypto companies, which, in turn, will experience some drop in their bottom line. Many users want to keep their identities anonymous. As such, the use of KYC, like Coinbase did recently in the Netherlands, will result in users being turned off.

There is much stronger evidence for the negative effects of KYC. ShapeShift CEO Erik Voorhees once said that the exchange lost over 95% of users after it implemented KYC.

Whether it's a well-known exchange like ShapeShift or an even more popular one like Binance, the vast majority of exchanges are complying with the law. As such, there may be a wealth of users going out of this side of the market into the more shady side. But remember, as mentioned earlier, the credibility afforded by KYC checks results in a wider swathe of new investors coming in.

These are growing pains that the crypto market will simply have to deal with. KYC implementation is inevitable as lawmakers bear down on an asset class that just keeps growing. There are crypto businesses focusing on building solutions that will make the whole process of identifying users easier as well — so there are changes coming from all fronts.

KYC May Be Good in the Long Run

Say what you will about the correctness of the new regulation, but it is inevitable that the crypto market will be regulated. Authorities cannot ignore the impact it is having on how we trade value with each other and are keen to impose their controls.

Having said that, crypto is by and large going to benefit from regulation because that adds to the legitimacy of the market. Many would-be investors are holding back purely because they feel that the market operates in a somewhat gray area. The credence lent to it by regulation, and by extension, a tacit government approval, will only benefit the market in the long run.