Know Your Transaction
Know Your Transaction” (KYT) is a term that refers to the process of monitoring and gathering information about financial transactions to identify any suspicious or potentially illegal activities. KYT involves the collection and analysis of transaction data, including the origin, destination, and nature of the funds involved. By employing KYT practices, financial institutions can detect and prevent illicit activities, such as money laundering, terrorist financing, fraud, and other financial crimes. It helps them monitor customer transactions, identify suspicious patterns or behavior, and report any potential concerns to the appropriate authorities.
Know Your Transaction v. Know Your Customer
While both part of a robust Anti-Money Laundering (AML) program, KYT is related to, but different from Know Your Customer (KYC). KYT centers around monitoring and analyzing financial transactions and involves tracking the movement of funds, identifying transactional patterns, and detecting any suspicious or potentially illegal activities. On the other hand, the objective of a KYC program is to verify and collect information about the identity of customers or clients.
Moreover, KYT is an ongoing process that continues throughout the customer’s relationship with the financial institution. It involves monitoring and analyzing transactional data in real-time or periodically to identify any unusual or suspicious activities. KYC is more static in the sense that KYC procedures are typically performed at the onboarding stage through the collection of customer identification data when establishing a business relationship with a customer.
Know Your Transaction Protocols
KYT typically involves utilizing various tools and techniques, such as transaction monitoring software, data analytics, and risk assessment models. Areas of focus include:
- Transaction Monitoring: Financial institutions must monitor financial transactions in real-time, flagging any transactions that exhibit suspicious patterns or characteristics.
- Risk Scoring and Alert Generation: Financial institutions must assign risk scores to transactions based on predefined rules and software-driven algorithms.
- Data Analytics and Pattern Recognition: Financial institutions must employ data analytics and pattern recognition techniques to identify potential money laundering activities, fraudulent transactions, or other illicit behavior.
- Watchlist Screening: Financial institutions must implement real-time screening of customers, counterparties, and transactional data against these lists to identify any matches or potential risks.
Much like KYC, the process of KYT is largely driven by complex software models. The major software providers for KYT are Actimize by NICE Systems, Oracle Financial Crime and Compliance Management (FCCM), SAS Anti-Money Laundering. However, depending on the financial institution’s business model – banks, money transmitters, e-money providers, cryptocurrency exchanges, etc., the choice and software and features contained therein will vary widely. Cost also becomes a main driver when considering KYT software.
FinCEN Regulation & KYT
Money service businesses (MSBs) operating in the United States are generally required to have a KYT policy as part of their overall AML compliance obligations. Under the Bank Secrecy Act (BSA) and its implementing regulations, MSBs are obligated to establish and maintain AML programs designed to prevent money laundering, terrorist financing, and other financial crimes. While KYT is not specifically mentioned in the Bank Secrecy Act or underlying FinCEN regulations, the requirement to monitor and identify suspicious transactions aligns with the KYT concept. KYT is generally accounted for through certain transaction monitoring policies such as Suspicious Activity Report Currency Transaction Report Policies.
KYT & Cryptocurrency
Cryptocurrency creates unique challenges for a compliant KYC program. In addition to the above-mentioned protocols, financial institutions such as cryptocurrency exchanges must also implement the following processes:
- Transaction Data Collection: Gather relevant information about the cryptocurrency transaction. This includes transaction hashes, wallet addresses (sender and receiver), timestamps, transaction amounts, and any other available metadata.
- Blockchain Analysis: Utilize blockchain explorers or specialized cryptocurrency analysis tools to examine the public ledger (blockchain) associated with the specific cryptocurrency. Explore the transaction history, trace funds, and gather additional details, such as the number of confirmations, block height, and transaction inputs/outputs.
- Address Clustering: Employ clustering techniques to group related wallet addresses based on transactional patterns, common ownership, or other indicators. This helps in understanding the flow of funds and identifying potential clusters associated with suspicious activities, such as mixing services or known illicit entities.
KYT in the context of cryptocurrency is particularly difficult in the absence of adequate software as well as use or exchange of certain privacy coins or cryptocurrency mixers.
As KYT is not specifically mentioned in prevailing AML & KYC statutes and regulations, many financial institutions may arrive at the conclusion that they do not have a legally sufficient KYT program or otherwise capturing only parts of a KYT program through other monitoring and reporting procedures. Nevertheless, the failure to maintain an adequate KYT program leaves the financial institution susceptible to unknowingly facilitating illicit transactions and thereinafter being a target of regulatory enforcement.
About Adam Tracy
Adam Tracy is a payments expert and entrepreneur who specializes in payment systems, blockchain technology, digital currencies, and other emerging technologies. He is the founder of Blockrunner, LLC that provides consulting services to clients in the blockchain, payments and cryptocurrency arenas.
Tracy has been involved in the payments industry as an attorney, consultant and entrepreneur since 2005, while he was become an expert in blockchain and cryptocurrency since its advent in 2013. Tracy has worked with a wide range of clients, including startups, established businesses, and investor – both in the United States and worldwide. He has advised clients on a wide range of compliance, legal and operational issues related to payment transfer systems, crypto token generation and architecture, cryptocurrency exchanges, regulatory licensing, smart contracts, and other blockchain applications.
In addition to his consulting work, Tracy has founded several companies in the payments, blockchain and cryptocurrency space, including a digital asset hedge fund, licensed electronic money institution and a blockchain-based tokenization platform. He is also a proponent of decentralized finance (DeFi) and has been involved in various DeFi projects.
Tracy is also a frequent speaker and writer on blockchain and cryptocurrency topics. He has been featured in a wide range of publications, including Forbes, CoinDesk, and Bitcoin Magazine.
Find Adam: https://linktr.ee/adamtracy