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With the UK no longer in the EU, the country has the chance to become a crypto powerhouse as alternatives regulations will apply. Mere KYC will not be enough in the proposed regulations as the aim is to encourage growth, competition and innovation in the market. We hear more from Rayissa Armata, the senior head of regulatory affairs at IDnow, the identity verification organisation. 

The high-profile collapse of FTX towards the end of 2022 was validation for those who had always doubted the safety and security of crypto. However, in the aftermath of such a significant event, attention is turning to regulations that will introduce new definitions and actions within crypto asset services in order to prevent market abuses and bring further transparency to the market.

Illicit activities and market abuse impact the reputation of those service providers who have always been compliant as well as new players who are coming to market. As the playing field evens out, expectations and the ability to meet new requirements will determine who stays and gains more user trust.

Know your customer (KYC) processes are not necessarily new to the world of crypto, but changes in the onboarding of new traders that will form part of the European Union’s Market in Crypto Assets (MiCA) legislation with the new application of Transfer in Funds Regulation (TFR) to the crypto space are wide-ranging. Service providers will need to collect and make available the personal KYC data collected from both the originator and beneficiary of a transfer. In this sphere, emphasis is placed firmly on consumer protection.

The MiCA detail

Existing KYC requirements that were issued under the EU Anti Money Laundering Directive 5 (AMLD5) and national AML law remain in place. Exchanges and cryptocurrency wallet providers will need to assess three fundamental points before they grant access to their platforms to fulfil the accompanying TFR requirements:

• The suitability of customers for various products available on their platform.
• That they understand the thresholds of different products and transactions which are to be introduced.
• That they understand new actions will be required between centralised and decentralised service providers.

The regulations also make clear to all crypto companies who is to be registered and licensed and determines what can be ‘passported’ under the licensing regime.

Furthermore, the new framework offers detailed rules and limitations for stablecoin issuers and establishes rules of transparency for crypto exchanges. These include real-time pricing and trade volumes, the settling of same day trades and the separation of funds belonging to crypto companies, and those belonging to clients with no insider trading.

The legislation passed into law in April 2023. Crypto companies now face a race against the clock to implement its requirements which are due within 18 months of the legislation becoming law (or late 2024). These requirements will be mandatory across the EU, but many are already in place in some member states, though not all. This 18-month implementation period will allow the member states to make the considerable investment and effort needed to implement evenly across the continent.

What TFR requirements providers need to know

TFR, on the other hand, will make use of digital identity verification by requiring crypto asset service providers (CASPs) to identify the senders and beneficiaries of digital assets. Ultimately, this ensures that KYC data on an end user is collected and completed before any funds are transferred. This data will be stored at both ends of the transaction and must be shareable with authorities upon request, under the ‘travel rule’, which is standard practice in a traditional finance transfer.

Such functions require personal identifiable information including the originator’s name, account number, address, ID number and date and place of birth.

Both MiCA and TFR face a tough but not insurmountable task to rebuild trust in digital assets after the multiple high-profile collapses in 2022. Supporters of the legislation believe it will enable greater protection for investors and users, limit liabilities, and encourage competition of services across the EU that should result in a more transparent industry.

Harmonisation has not been easy, but MiCA has permitted many to see it as a general consensus that comprehensive rules can be a model for the rest of the world. The USA in particular is looking on with interest after its recent enforcement-based approaches to regulation did not achieve the level of impact they initially sought.

Thanks to one particular political decision, the UK is also observing with keen interest and has introduced its own draft legislation for the sector.

Post-Brexit crypto trade

Since the UK departed the EU, the country has had the opportunity to make their own laws and regulations in countless fields and sectors. As is commonly pointed out, the UK does so by applying a risk-based approach. Trade in cryptocurrency is one area included in this focus.

Rather than producing a carbon copy of MiCA and TFR, the government has instead undertaken an in-depth look at the issues surrounding all things crypto. Its iterative approach has included a two-phased tactic: the first contained consultation on flat and stablecoins, while the second evaluated the best ways to regulate activity in crypto to reduce the ways in which it is abused and potentially used to fund terrorism.

The regulations that the UK puts in place will apply to all companies registered in the country. However, they must also be fulfilled by companies which offer their services to customers in the UK as well. Consultation on both phases is due to close at the end of April 2023.

A different approach from that of Europe

One area where the UK’s proposed regulations differ from MiCA is in the requirement to strengthen rules for exchange and custodial services. Registering and performing a simple KYC process will not be enough. Instead, comprehensive requirements around lending together with greater transparency on public disclosure information is also likely to be a feature.

The scope also includes in-depth detail on tokens including exchange, utility, non-fungible, asset-references, commodity-linked, crypto-backed, algorithmic, governance and fan tokens. It will encompass those activities related to intermediation and lending as well as the traditional custodial and exchange activities.

Principally, the goal will be a uniform framework for crypto activity in the UK and beyond, with policy objectives that are comparable to MiCA: namely to encourage growth, competition and innovation, resulting in more transparency and stability in the crypto market.

Whatever the regulation, KYC is here to stay

As with MiCA and TFR, the road to implementation in the UK is long and will be met with significant investments. The place of KYC processes in the regulation means that they will be a fixed design of any future legislation, now that their positive impact has been recognised. Ultimately, these regulatory frameworks should give service providers the ability to offer a platform where users can make investments based on well informed decisions and with an understanding of the risks involved in this new market.