In March 2024, the European Parliament greenlighted a ban on anonymous crypto transfers. If it officially passes into law, it will take effect in 2027. However, the reactions are mixed—some crypto experts and cybersecurity professionals believe mandatory crypto KYC solutions could compromise personal data safety.
Crypto KYC solutions introduce security risks
Forbes Magazine reminds us hardware wallet Ledger recently launched a crypto KYC solution that lets users recover private keys. The solution, Ledger Recover, works by dividing the seed phrase into three encrypted sections, which third-party custodians store securely.
According to experts, the crypto KYC solution's API might reveal the seed phrase, thereby undermining hardware wallets' security model. Moreover, they are worried the government would have the authority to subpoena the platforms holding the encrypted seed phrase parts, potentially accessing customers' finances.
Ledger "alienated" its client base
Critics of this crypto KYC solution believe Ledger alienated its client base, citing several reasons. First, the hardware wallet was accused of misrepresenting how its devices worked. Users of the Nano X wallet did not need to add any updated firmware to access the service, meaning that Ledger always knew accessing seed phrases was possible.
Secondly, the idea of a cryptoKYCsolution to use the service displeased users. It's rarely a good idea to have a list of Bitcoin holders. Such lists can get leaked. In 2020, Ledger suffered a data breach, illustrating the risks when you rely on third parties. The breach exposed many users' names, email addresses, and phone numbers. They started receiving threatening messages and suffered phishing attempts.
Risks of verification services
A public list of Bitcoin holders makes them convenient targets for governmentsand defeats the whole notion of blockchain: a way to keep your assets private.
Finally, some see Ledger's new crypto KYC solution as a poor multi-signature substitute and potentially creates a whole series of situations that are much riskier than the one you're trying to solve.
Another risk associated with crypto KYC solutions involves showing your passport to regain access to an account. Potentially, a hacker could do the same.
The clash between blockchain and KYC
There is an inherent clash between KYC and crypto, both ideological and technical. When someone wants to reverse an illegal transaction in traditional finance, they use documents to prove they own the respective assets. This approach does not align well with the anonymous and decentralized ethos of the blockchain.
Transactions are permanent in the blockchain world; once they occur, they cannot be reversed. Essentially, crypto KYC solutions may provide fewer opportunities for asset recovery than for theft.
Experienced users dislike crypto KYC solutions because they don't want to give up control of their personal data, not because they want to launder money or evade taxes. Considering how many data breaches there have been, it's normal that uncertainty about how securely services store personal data prevails.
How easy is verification to bypass?
Most mainstream crypto exchanges have KYC rules in place. They insist these mechanisms make it easier to intercept suspicious activity, enhancing the security of customer assets. However, users can find ways to circumvent these rules, and exchange employees might check documents improperly. Blockchain sleuths and journalists frequently demonstrate how people use fake names and documents to bypass verification on various exchanges. Their deceptive tactics successfully fooled employees at leading crypto platforms.
Pros of crypto KYC solutions
Despite concerns about crypto KYC solutions' vulnerabilities, they are becoming more common. Most leading centralized exchanges now require users to undergo KYC, but these solutions are still a major protection mechanism. Some of the best platforms combine blockchain and traditional finance, using crypto KYC solutions to protect customer data and maintain financial freedom. They can be critical for enhancing trust and security within the financial ecosystem.
Crypto KYC solutions help combat terrorist financing, money laundering, and other illegal activities by ensuring proper user identification. The verification process protects honest users by creating a more transparent, safer transaction environment. What's more, KYC is essential for regulatory compliance, helping crypto exchanges operate legally worldwide.
Platforms operating without mandatory verification are very rare nowadays. Multifactor authentication only requires an email and a phone number. Security also improves because users can set a separate withdrawal code. Even if someone accesses their details and enters them on a phishing site, they will not lose their funds because different codes are needed for access and withdrawal.
One can improve security by creating a master key that allows for one-time account access restoration. When activated, the key triggers a crypto transfer to an emergency withdrawal address, protecting the assets even if the account is hacked.
If you lose your 2FA or password, the master key's security feature lets you withdraw your funds and close your account. Even if your master key is stolen, your crypto is automatically sent to your pre-designated address.
Recap
Most major centralized exchanges have implemented crypto KYC solutions, but these should not be seen as a mandatory mechanism. KYC checks may be standard in traditional finance, but these systems are vulnerable to attacks and don't guarantee the security of user funds. In the world of cryptocurrencies, many users see them as contradicting the basic principles of decentralization, exposing data to potential breaches, and posing risks to financial freedom.
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