The rise of the crypto industry during the last few years has drawn the interest of people looking to invest in other non-traditional products. As of November 2022, it is estimated that the market capitalization of crypto is $831 billion (as per Coinmarketcap).
The characteristics of the blockchain, the technology behind crypto, such as the ability to transfer funds quickly between multiple jurisdictions, make it attractive to people who perform legitimate transactions but also to criminals. As a result, regulators worldwide are trying to protect the industry by bringing the crypto asset sector under anti-money laundering rules and preventing the industry’s misuse for criminal purposes.
Entities offering crypto asset services are now required to conduct KYC and CDD on their customers, perform due diligence on transactions, and file Suspicious transactions/activities.
What is KYT
KYT stands for “Know Your Transaction” and is a process where regulated entities examine transaction-specific data to identify and assess the risk of money laundering and terrorist financing associated with customers’ transactions. KYT aims to identify whether a transaction is standard and in line with the client’s business activities or whether it is unusual, unnecessarily complex or potentially linked to criminal activity.
KYT in crypto
KYT is an essential element of the anti-money laundering (AML) program in the crypto industry. It provides the crypto asset provider with the information needed to understand the nature of the transaction and the patterns and identify high-risk transactions or associated transactions that are potentially related to money laundering or terrorist financing (ML/TF). However, as the crypto industry continues to grow and financial institutions become involved in cryptocurrencies, they need to consider KYT as part of their AML program.
KYT can assist banks and financial institutions in focusing on the persons involved in a transaction and the historical characteristics and connections of a specific transaction. Additionally, KYT makes it possible to monitor the flow of funds associated with a wallet address and enables entities to assess the legitimacy of a transaction.
KYT has the following benefits:
- Identifies the risk level associated with a wallet address
- Checks whether crypto wallet addresses are related to high-risk activities
- Identifies the category and industries to which the wallet address is connected.
- Shows behavioural and country risk indicators
How KYT works
KYT obtains blockchain forensic information to specify a transaction’s risk score and risk category. For example, in the case of incoming transactions, the KYT tool screens the transaction using a blockchain forensics platform and receives back the risk score and category. Then, according to the regulated entity’s internal policies, the transaction may be rejected or accepted.
As a result, it is possible for a regulated entity to identify whether the source of cryptoassets is tied or indirectly linked to illicit activity.
Do companies need to employ KYT tools?
The FATF and the EU directives require regulated entities to apply ongoing monitoring of the customers’ information and transactions to ensure that they can identify potential suspicious activity.
Although some companies still rely on a manual transaction monitoring system, this is now considered a non-effective method of monitoring transactions. Transactions in crypto use blockchain, one of the most innovative recent technological developments. As a result, it is almost impossible for a company to monitor customers’ transactions manually and effectively.
For example, in October, FinCEN in the US announced a $29 million enforcement action against Bittrex, a crypto asset provider. In its consent order, FinCEN stated that one of the AML failures of the firm was that “instead of utilizing widely available transaction monitoring software tools to screen the transactions for suspicious activity, the company relied on two employees with minimal AML training and experience to review all of the transactions for suspicious activity manually”.
For cryptocurrency transaction monitoring programs, regulated entities must employ automated transaction monitoring tools to enable compliance departments to comply with the Financial Action Task Force (FATF) rules on crypto.
On the other side, regulators worldwide consider using KYT tools of high importance to comply with the AML regulatory requirements in the crypto industry. Failure to do so may result in significant exposure to legal risks, penalties, and reputational damages.