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The trend towards cryptocurrency de-anonymization

Modern bureaucracy has long been striving to eliminate any anonymity from the financial world. For example, in banks of any country, it is nearly impossible to open an account or obtain a loan without providing identity and creditworthiness documents. Even purchasing cash currency often requires presenting a passport. Meanwhile, cryptocurrencies have remained a "haven of anonymity" amidst the diverse range of financial instruments. However, the situation has dramatically changed in the past two years.

The starting point is commonly considered January 10, 2020, when the Fifth Anti-Money Laundering Directive (5AMLD) came into effect, adopted by the international community. Since then, many cryptocurrency services have introduced mandatory identity verification for their users on a massive scale.

Nevertheless, all financial systems have long been using customer verification principles to prevent fraud and combat money laundering. The integration of crypto services into previously adopted principles was entirely expected and consistent.

Such a step is primarily associated with the social responsibility of businesses and the protection of customers from fraud. However, with the introduction of new legislation, the failure of these services to comply with KYC verification can become a basis for criminal prosecution, even if the organization itself operates legally and honestly. In fact, all crypto services that intend to work with fiat currencies in any way are obligated to comply with the principles of the international community.

KYC (Know Your Customer) is a principle used by financial institutions (banks, exchanges, bookmakers, investment and mutual funds) that requires them to identify the counterparty's identity before conducting a financial transaction. Customer identification (KYC) is only part of the measures against money laundering (AML).

Compliance with KYC policies by users and cryptocurrency exchanges enables faster conversion of cryptocurrencies into real money in both cash and non-cash forms. In exchange for anonymity, cryptocurrency users gain security and the assurance of the legitimacy of their funds.

AML (Anti-Money Laundering) refers to a set of measures adopted by the non-governmental international organization FATF (Financial Action Task Force) aimed at combating money laundering from criminal activities, preventing the financing of terrorism, and the financing of weapons of mass destruction.

However, it is worth noting that the main idea behind cryptocurrencies was never linked to anonymity. Moreover, if one studies the documentation of Bitcoin, they will find nothing about anonymity. The pseudoanonymity of most blockchains turned out to be a pleasant bonus, but the main purpose of creating Bitcoin was to free users from the censorship of financiers and politicians.

Bitcoin transactions between two wallets cannot be frozen, reversed, or prohibited.

However, today cryptocurrencies are not the foundation of the financial system, so they must integrate into the existing system.

In order to legalize and accept cryptocurrencies in society, the crypto community has abandoned certain principles, including anonymity. And when it becomes necessary to work with fiat currencies, they also compromise the fundamental principle of decentralization by subjecting themselves to censorship in centralized communication nodes connecting cryptocurrencies to the traditional financial system (cryptocurrency exchanges, exchange offices, payment systems, and gateways).

Various actions by crypto-anarchists and advocates of anonymity in response to this trend are quite understandable and justifiable. However, unfortunately, attempts to maintain the status quo have no real basis or societal strength.

Any official business involving fiat currencies must adhere to international standards under the threat of criminal prosecution. Therefore, as ordinary users, we must accept these rules of the game if we want to have such gateways between Bitcoin/Ethereum and the dollar/euro.

Cryptocurrency services not only bear responsibility for their customers' financial assets but also play a role incombating illegal money laundering.

However, if someone is dissatisfied with such a state of affairs, decentralized exchanges (DEX) and other DeFi services continue to be available on the network. But obviously, they are not suitable for working with fiat currencies, which require mandatory KYC procedures and compliance with AML principles.

Money laundering schemes are illegal in all civilized countries, but the stringency of KYC and AML principles is usually determined by each financial institution independently.

In any case, if we consider exchangers with official "crypto licenses" from different countries, they are simply required to comply with the legislation of those countries, which always implies adherence to anti-money laundering directives (AML), i.e., the practice of implementing KYC.

At the same time, other exchangers that do not have the opportunity to formalize their activities (i.e., they comply with the country's legislation but, due to the simple lack of registration options for their activities as exchange points, are ordinary individual entrepreneurs/LLCs or their equivalents in neighboring countries) try to continue following a hybrid model at their own risk - they turn a blind eye to mandatory KYC procedures if the risks of money laundering or fraud are minimal.

However, when the risks are high or operators have other suspicions, they require users to undergo identity verification. Usually, following the identification of risks, transactions are frozen to prevent any fraudulent actions on the platform, and then identification of the sender's identity is requested. But this is usually done at the request of a third party - a custodial service used by the exchanger to store its cryptocurrency.

Summarizing the trend of the last two years in the cryptocurrency community, we can talk about the end of the era of anonymous exchanges. If previously identity checks were relatively rare, in the last couple of years, the absence of verification is more of an exception to the rule and, in a sense, even a competitive advantage. Therefore, those of us who enjoy all the benefits and blessings of the civilized world will have to accept the principles and sacrifices that these benefits entail.

On the other hand, if we evaluate the objective side of the issue, there is nothing terrible about the fact that the crypto industry has matured and has come to some self-regulation and purification from obvious dirt. We live in a society where almost any financial transaction, except for small daily expenses, involves de-anonymizing the payer. We are not surprised that banks ask for passports to open an account, so we should not perceive it as something terrible when the same happens with crypto services. These are the inevitable consequences of the wider acceptance of cryptocurrencies in the world, beyond being just an exotic form of exchanging information.

© – , updated 08/29/2023
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