Blockchain & KYC

Gary Schwartz speaks to Diana Adachi on the new token economy and how security-based tokens are becoming a standard offering. We discuss the evolution of KYC / AML solutioning in a decentralized marketplace.

ICOs are defined by Investopedia as an unregulated capital raise not registered with any government organization lacking investor protection. Is this changing?
There is a maturity in the evolution of ICO’s as Regulators Globally have begun to voice their opinions on Token offerings.The key consideration every company who will be launching an offering is to start with their token as a security regardless of its utilitarian value.
The math here means that 90% of the tokens globally can only be traded to drive value, so they are certainly speculative instruments. However, you say ICOs should start with the assumption that “their token [is] a security regardless of its utilitarian value.” Why?
Like shares, a token in an ICO offers the investor a potential upside in the appreciation of the token however without further dilution to the company. A token with a utilitarian value could also attribute to the increase in value.
However, ICOs are, for the most part, still unregulated, which is why they are increasingly being used by start-ups as a means of circumventing the regulated capital-raising process required by venture capitalists and banks.
I understand why Governments and regulatory bodies want ICO transparency, as it can help prevent money laundering and other forms of corruption. However, AML legislation was designed for existing centralised fin services systems not for the intrinsic anonymity of ICO process.
What is the benefit for the company running an ICO to go down the rabbit hole of regulatory compliance?
ICO’s in the past never considered their tokens as securities largely because they were unaware of the securities laws. Most viewed their tokens as a utility and even today there are companies who still dont understand having their token on an unregulated exchange is a issue
There are companies willing to circumvent securities law within their jurisdiction; however many ICO are uninformed and rely on their legal counsel. It is critical to have a securities lawyer evaluate the ICO before they launch .
In the Bitcoin world the innovation is any two entities or individuals anywhere in the world who are unknown to each other can transfer value immediately without a centralized intermediary. The individual does not go through any KYC; they are for the most part anonymous.
ICO’s need to need to adhere to the rigor and requirements of Know Your Customer (KYC) and Antimoney Laundering (AML) beyond just to meet the regulatory concerns. Consider, the credibility of the project particularly with banks and even make post-funding tracking even easier.
KYC/AML will allow companies to identify who their investor is and more importantly ensure they are accredited.
Beyond simply appeasing regulatory bodies and assuaging their concerns, are there other benefits for companies that ensure their ICOs comply with strict oversight and compliance?
Yes, companies who are compliant will protect their brand and image long term. The give an assurance that their crypto assets are safe-guarded, secure and designed including governance.
Governance is key as it presents to the world your focus on oversight and that as an issuer you are predictable and secure. From an investor stand point their investment in you is a good.
There is no question that strong KYC during an ICO can help the company establish credibility with the street. Incorporating KYC | AML process into a sale makes post-funding tracking easier, allows companies to identify their investors and confirm their accredited status.
Outside of the blockchain there are many existing KYC service that help manage documents and share them with multiple entities. Many do not perform due diligence. DD and investigation are handled by the bank or broker. On the blockchain there is no custodian.
FI are penalized for failing to follow KYC guidelines. Some banks are turning to the blockchain as a possible solution to the KYC challenge. With your experience with Ripple and other banking platform what are your thoughts on the future of bank-grade KYC?
The banks are still responsible for KYC even when they use Ripple as this banking platform only enables real-time settlement between banks.
Banks and money service providers must have a bank-grade KYC which at ensures the customer at minimum is not any OFAC list based on the jurisdiction they are moving money.
KYC and Identity on a blockchain is the holy grail as all attestations can be made public and transparent while PII is locked into cold storage and non accessible.
Thomson Reuters 2016 KYC surveys show that there are escalating COSTS and COMPLEXITY. Financial firms’ spend of up to $500 million annually on KYC globally. 89% had a poor KYC experience, and 13% had changed their financial institution relationship as a result.
Would blockchain-based KYC ledger remove the duplication of effort in carrying out PII and AML checks? If this ledger item is simply a hot record (actual information held in cold storage) would create efficiencies and speed up the existing process?
Would a universal token for an individual’s KYC and, most importantly, the corresponding Customer Due Diligence (CDD), eliminate some of these costs and complexities?
Assuming the universal token is essentially acting as a proxy to the individual and the underlying PII is attached to that token then it could reduce the costs and complexities.
Cost and complexities to implementing KYC and AML are a result of older analogue processes that need to evolve with enabling technologies like blockchain and the internet where real time transfer of value and information is achievable
Another consideration is the sophistication of circumventing the existing KYC and AML systems/processes by bad actors is also increasing at a faster rate and hence the need for a revolutionary change sooner rather than later.
Do you anticipate a heightened level of consumer due diligence around KYC on the blockchain given the perceived risk associated with this pseudonymous network? Below is Thompson Reuters KYC pyramid of compliance.
Yes. Regulators will expect it and companies want it as they recognize their exposure without a comprehensive KYC/AML. Check Crypto KABN latest biometric ID validation announcement.
Diana, Thanks for your time. Look forward to learn more as the industry matures.