We live in an ever-evolving financial world with new innovations and technological milestones. As the government enacts laws and regulations to keep financial crimes and other illegal activities from spreading, criminals find new ways to cheat, manipulate and bypass the rules. The speed and number of daily transactions on digital channels have skyrocketed. Countless fraudulent transactions are hidden within, made under various guises. Moreover, with the growing adoption of cryptocurrency assets and payment methods, financial institutions must be able to investigate crypto transactions for evidence of financial crimes. It is evident that financial institutions must step up their efforts to follow the money. In recent years, KYT – Know Your Transactions – has emerged as another powerful tool for addressing the risk of money laundering, fraud, and terrorism funding.
What is KYT?
Know your transactions (KYT) is an essential compliance tool for financial institutions and other regulated businesses that engage in financial transactions. KYT refers to identifying potentially suspicious activity in the transaction of customers that could indicate money laundering, transaction laundering, funding of diverse illegal activity, and other financial crimes. It involves a lot of monitoring and analysis of individual transactions. Designed as a proactive measure, it aims to prevent financial crimes and maintain the integrity of the financial system. KYT is a crucial component of an institution’s anti-money laundering (AML) and counter-terrorist financing (CTF) compliance system.
Regulatory bodies such as Financial Crimes Enforcement Network (FinCEN) and the Financial Action Task Force (FATF) emphasize KYT and other transaction monitoring measures to combat financial crimes. Businesses in specific industries must implement transaction monitoring measures, such as KYT, as part of their overall compliance programs. Failure to comply with these requirements can result in significant penalties, including fines, suspension or revocation of licenses, and criminal prosecution in some cases.
How Does KYT Work?
KYT targets real-time transaction data and monitors it continuously. It links customer profiles created during the Know Your Customer (KYC) process with their transactions. To detect financial crimes, transaction information, such as invoices, contracts, IP addresses, etc., is collected and analyzed to identify potentially risky transactions. KYT is accomplished by integrating technology and data analytics tools, including artificial intelligence and machine learning models, data visualization tools, and advanced analytics platforms. They enable financial institutions to collect, process, and analyze data in real-time, identify patterns and anomalies in customer transactions, and generate alerts for timely action. These tools take note of the following:
- Unusual transactions that are inconsistent with the customer’s profile or previous transactions,
- Transactions that involve countries and entities associated with money laundering or terrorist funding,
- Transactions involving large amounts of money, especially if they are not in tandem with the customer’s known income or business activities,
- Transactions that seem like layering or involve multiple intermediaries.
- Cryptocurrency-related transactions
- Transactions that are structured to avoid triggering reporting thresholds, etc.
KYT Workflow
KYT provides data-driven conclusions that alert the appropriate departments or authorities for appropriate actions to be taken. If a transaction is suspicious, financial organizations must file a Suspicious Activity Report (SAR) with the FinCEN and other relevant law enforcement agencies. It makes it easy for criminals to be traced and made to face the law, thereby securing the financial system. In much clearer terms, this is how KYT works:
- Financial institutions assess the risk associated with different types of transactions and customers. Their analysis helps them determine which types of transactions are most vulnerable to financial crimes and which customers are most likely to engage in suspicious behavior.
- With the risks identified, financial institutions monitor transactions in real-time using automated transaction monitoring systems.
- The system generates an alert and sends it to the institution’s compliance team for further review when it detects suspicious activity.
- Further investigation into the transactions will reveal if the suspected activity is related to money laundering, transaction laundering, or terrorist financing.
Relevant regulatory authorities are notified if necessary. Additionally, the institution can freeze assets involved in the transaction to prevent further suspicious activity. Financial institutions keep records of all transaction monitoring activities and investigations to demonstrate compliance with regulatory requirements and conduct internal audits.
KYC vs. KYT
Know Your Customer (KYC) is a crucial element in the customer onboarding process. KYC is a regulatory process that mandates businesses to gather information about their customers to authenticate their activities and assess the potential risk of doing business with them. KYC verifies the customer’s information, such as name, address, date of birth, and government-issued identification, at the beginning of the customer relationship.
On the other hand, KYT is an ongoing process that monitors and analyzes customers’ transactions to identify and report suspicious activity. KYT is often referred to as the future of KYC. KYC alone is insufficient to ensure compliance with regulatory bodies and secure the financial institution, as continuous monitoring is required. A combination of KYC and KYT processes is what an institution needs to gain a more comprehensive understanding of its customers and their transaction activity. KYC and KYT form a robust system for managing and mitigating financial crime risk, ensuring regulatory compliance, and reducing penalties.
Benefits of KYT
KYT systems offer valuable insights to financial institutions, benefiting them in several ways, such as:
- Improve their Customer Due Diligence.
- Detect financial crimes.
- Enhance their reputations.
- Improve their risk management.
- Detect Suspicious patterns in Transactions.
- Improve compliance with regulatory requirements.
- Prevent financial crimes.
- Improve customer experience — by preventing fraudulent activities, KYT helps to protect customer assets, thereby increasing customer loyalty and satisfaction.
- Improve internal controls — KYT systems help financial institutions identify weaknesses and vulnerabilities in their processes and procedures, strengthening their internal controls.
Who Should Use KYT?
Financial institutions subject to regulatory compliance requirements typically use KYT to mitigate risks and prevent money laundering, fraud, and other crimes. This proactive approach allows them to maintain a secure and compliant business environment. However, more businesses should consider using KYT, especially businesses that:
- Handle large volumes of transactions.
- Operates in high-risk industries like cryptocurrency and other financial services,
- Has experienced financial crime in the past and wants to improve its risk management.
KYT and Transaction Laundering
Transaction laundering disguises illicit transactions to appear legal, also known as electronic money laundering. It involves hiding the true nature of transactions by passing them through legitimate businesses to make them appear legal. A criminal uses a legitimate merchant account to process illicit goods or services payments. For example, a website selling counterfeit goods might use a legitimate payment processor to process transactions. Legitimate merchant accounts unknowingly conceal the true nature of transactions from law enforcement and financial regulators.
Transaction laundering is a serious financial crime that can have far-reaching consequences. Among its uses are terrorism financing, drug trafficking, human trafficking, and other illicit activities. By monitoring transactions in real-time, analyzing data, and flagging suspicious transactions, KYT helps curb transaction laundering.
KYT in Cryptocurrency
Detecting and preventing financial crimes can be challenging in cryptocurrency transactions due to the anonymity and decentralized nature of the blockchain, making KYT particularly relevant in this space. KYT is critical to cryptocurrency businesses’ AML and CTF compliance efforts. Cryptocurrency is frequently linked to illegal activities like drug trafficking, money laundering, and financing terrorism. KYT can address these challenges by providing real-time insights into cryptocurrency transactions, enabling businesses to detect and prevent fraudulent activity, money laundering, and other financial crimes. Therefore, it is essential for businesses operating in the cryptocurrency industry to implement effective KYT measures to avoid legal and reputational risks.
Cost of Effective KYT Implementation
The expense of KYT implementation varies for financial institutions and businesses, depending on their size and operational complexity. Some cost factors to consider are:
- Staffing costs — Implementing and managing the KYT process requires hiring some staff.
- Training costs — Institutions must provide periodic training to their staff to ensure they know the KYT program’s policies and procedures and can effectively perform their roles.
- Legal and consulting costs — for getting legal or consulting services from professionals to help design and implement an effective KYT system.
- Technology and operational costs — This goes into purchasing KYT software and applications for transaction monitoring, data analysis, and reporting. It also includes operational setup costs; KYT systems can be resource-intensive, requiring significant computing power and storage capacity.
Although these costs can be high, they are well worth it.
Challenges associated with KYT
Despite its several benefits, KYC implementation comes with its challenges, including:
- Implementation and maintenance costs.
- The risk of false positives — KYT systems may flag legitimate transactions as suspicious. This can result in additional administrative work and customer frustrations.
- Data privacy concerns — KYT systems require access to sensitive customer data, which raises privacy concerns.
- Limited effectiveness — KYT systems may not detect all instances of financial crimes. This is especially true when criminals use sophisticated methods to hide their activities. Companies must supplement KYT with other anti-money laundering measures to improve their effectiveness.
Conclusion
KYT as a transaction monitoring tool is essential. KYT helps identify and mitigate financial crime risks, such as money laundering and terrorist financing. By implementing KYT compliance measures, businesses can enhance risk management, improve compliance, and provide a better customer experience. KYT is not just for financial institutions but also other businesses engaging in financial transactions. As KYT evolves, financial institutions and other businesses must stay updated on its latest developments.
Identity.com
As a company leading a blockchain technology that will be helpful in the finance industry, we also believe in the ability to reduce fraud and all irregularities in the financial world. More reason Identity.com doesn’t take the back seat in contributing to this future via identity management systems and protocols. We also belong to the World Wide Web Consortium (W3C), the standards body for the World Wide Web.
The work of Identity.com as a future-oriented company is helping many businesses by giving their customers a hassle-free identity verification process. Identity.com is an open-source ecosystem providing access to on-chain and secure identity verification. Our solutions improve the user experience and reduce onboarding friction through reusable and interoperable Gateway Passes. Please get in touch for more info about how we can help you with identity verification and general KYC processes.