KYC for Market Makers: A Case for Advanced Identity Proofing and Institutional Verification

Market makers are an important and often-misunderstood component of the crypto and decentralized finance (DeFi) ecosystems. 

By providing liquidity to crypto markets, market makers allow exchanges and token-based projects to gain traction and recognition, providing them with the opportunity to grow. 

However, because their key activities are largely centered around transactions, they are also especially susceptible to regulatory oversight. Ensuring they know who they are dealing with - and the given risk factors associated with them - is especially important in terms of compliance. 

As with many other dimensions and actors of the crypto industry, the need for greater transparency, oversight and risk mitigation remains significant. The challenge for market makers - as is the case for most companies faced with the obligation to comply with global financial regulations - is how to ensure robust KYC/AML processes are being implemented comprehensively, efficiently and cost-effectively. 

This applies in two directions: 

Token projects, exchanges and other financial institutions enlisting the services of a market maker need to be sure they are dealing with a responsible actor that does not engage in controversial practices - and end up harming their credibility and/or legal standing. 

At the same time, as a market maker, you need to ensure that the clients you agree to provide services to are themselves not associated or implicated in sanctioned activities such as money laundering or terrorist financing. 

As is the case with many other transactional relationships in the traditional finance, DeFi and Virtual Asset (VA) ecosystems, global regulators tend to treat guilt by association seriously. Doing business with a sanctioned entity - or indirectly facilitating money laundering through providing financial services to a criminal actor - can land businesses in a lot of trouble. 

With that in mind, market makers will be well-advised to institute robust KYC/AML protocols when deciding whether to provide services to prospective clients, whether they are an individual running an exchange, a collaborative DeFi platform or token project; or just a traditional corporate client.

In a highly informative article on Hackernoon, Jakob Palmstierna, leading market maker GSR’s director of investments, goes into considerable detail on the various regulatory issues (and moral considerations) surrounding the practice, as well as best practices in the space. In the article, Palmstierna makes the case that market makers need to comply with basic KYC/AML rules if they are to avoid detrimental - and potentially illegal - market or transactional activity. 

However, fast onboarding of clients through robust ID proofing and comprehensive checks against AML risk factors are difficult processes to reconcile when attempting to carry out KYC checks manually. Manual KYC checks often result in non-uniform data sets that carry a greater risk of human error - all while using up time and resources that can drive a company’s margins into negative territory. 

That’s where automated KYC solutions like KYC-Chain come in. Using our end-to-end workflow solution, market makers can use KYC-Chain to conduct full identity proofing of their potential clients, allowing them to build informed and complete risk assessments before choosing to go ahead with a contract (or not).

The need for greater regulatory oversight of both projects enlisting market maker services - and of market makers themselves - is essential if the broader crypto space is to grow in a healthy, responsible way. The danger of unscrupulous token projects and agents artificially inflating market trading under the guise of market making - so-called ‘wash trading’ - is significant, and places unfair burdens on legitimate actors in the space.

Using our Accredited Investor Verification (AIV) tool, our market maker clients can ensure the projects/clients they onboard are backed by verified actors and entities. The Accredited Verification feature works by checking global investors against a range of government databases and registries. All AIV checks are carried out by a registered attorney, ensuring Enhanced Due Diligence (EDD) prior to onboarding. 

This allows a company to remain fully compliant with US Securities and Exchange Commission (SEC) rules on doing business with securities traders, which are being increasingly applied to both security and utility token sales.  

ID Proofing = KYC ? 

As the crypto space continues to evolve and expand, so too does the interest and attention of both criminals and regulators. With near-constant innovation on the part of nefarious actors seeking ways to bypass existing AML safeguards, having robust and dynamic KYC processes in place to mitigate the risk of fraud and other criminal activity is essential.

ID Proofing can be considered the first and most important line of security against these risks.

ID Proofing is - as the name suggests - the process of using biographical information and “transaction information aggregated from public and proprietary data sources” in order to verify an identity before issuing its owner with an account, credentials or services.

Everyone using a digital device or service is usually passing through numerous ID proofing processes daily - from password checks to uploading a selfie holding a passport page in order to open a crypto trading account - these processes are all designed to ensure we are who we say we are.

In the financial world, Identity Proofing is often used interchangeably as KYC. However, there are also some nuanced distinctions. 

Identity proofing is a critical component of KYC, but it is not all there is to it. While verifying an identity is one thing, actually understanding the risk profile of that identity requires additional, usually more complex checks and research - what is termed in the compliance world as Enhanced Due Diligence (EDD).

For market makers, ID proofing is often the first - and sometimes the only - step they take before choosing to onboard a new client. 

ID Proofing in the context of both corporate and individual KYC can be separated into two symbiotic categories: 

1. Document-centric checks: on ID documents such as passports, national IDs, etc; and selfie checks. 
2. Data-centric checks: comparing data points (DOB, first name, last name, nationality) with a government registry (residential files, corporate appointments, etc.) which can be extended for Corporate KYC verification through company registry checks, and drilling down to UBO discovery and verification.

These two types of checks cannot be separated or used selectively, as their utility is co-reliant. With the advancement of digital capabilities such as so-called ‘deepfake software’, there is a real need to check ID documents and selfies against objective, verified third party databases. Triangulated ID proofing techniques can be used to mitigate the risk of counterfeited ID documents or even fabricated selfie uploads being used to open/access accounts by false identities. 

Using KYC-Chain, our market maker clients, which include industry leaders GSR and Acheron Trading, are able verify their customers with confidence. By using our ID Verification tools, Customer Due Diligence (CDD) checks, and corporate KYC features, our clients are able to ensure their clients are who they say they are - regardless of whether they are an individual or a company. 

Our end-to-end workflow solution allows our clients to carry out ID Proofing that involves ID checks, selfie comparisons, and document verification against hundreds of government databases and corporate registries. 

Our tool also cross-references prospective customers against AML watchlists that include sanctions lists, PEPs and adverse media to build credible, automated risk profiles. For corporate clients, we run automated checks against over 160 government corporate registries to ensure a company is real and non-sanctioned, and facilitate UBO discovery and verification.

Are you a market maker looking to implement industry-leading KYC technology in your onboarding processes? Get in touch and we’ll be happy to have a conversation about how KYC-Chain can be your trusted partner.