Modern fraud prevention measures stifle crypto market growth

The number of cryptocurrency users on the global market has reached approximately 425 million or about 8% of the world’s connected population (est 5.44bn). That number, while impressive, falls far short of the optimistic adoption estimates investors were touting just a few short years ago. Crypto.com, for example, predicted a market in excess of one billion users back in 2022.

A slow-growing user base has hurt the value of cryptocurrencies. The reduced liquidity of smaller markets makes it harder for traders to execute large orders without impacting prices, which in turn tends to generate more volatility and makes investing in cryptocurrency a risky proposition for the masses.

Markets run efficiently when they are full, as they create a more realistic market price. This also drives diversification opportunities, improves price discovery, and supports a larger selection of crypto tokens.

A number of reasons keep investors away from cryptocurrency opportunities, including a lack of understanding of blockchain, security considerations, and regulation. However, one overlooked factor preventing more widespread adoption is the unrequired KYC protocols put in place to prevent fraud.

The process for a new user to sign-up to an exchange should be simple, fast, and easy. You would expect to be able to buy cryptocurrency in seconds, using a credit card. That process, however, rarely works for new customers due to concerns of fraud.

New users are systematically subjected to long and complex KYC processes, that include email and telephone verifications, captcha solving, picture ID verification, and face video capture.

Transactions via credit card are not always allowed, and ACH transfers are limited to small amounts. Transactions are then often routed through 3DS, where they are unnecessarily rejected by issuers or by exchanges that use inefficient rules to protect against costly chargebacks and penalties.

Know-your-customer (KYC) is an interesting example of an often unnecessary rule. Exchanges are required by law to comply with KYC regulations. However, many go beyond the requirements of the law, hoping that more KYC will protect them against fraud. For example, in the United States, KYC has a $3,000 threshold before it is required. Any cryptocurrency purchase below that threshold doesn’t require KYC. Yet, all crypto exchanges put new customers through their KYC protocols for purchases as low as $100.

The unfortunate reality is that not only does an estimated 80% of fraud come from KYC-verified accounts, but it stands as an additional barrier to entry for new investors. Fraudsters have learned how to get around KYC requirements, purchasing KYC-verified accounts for as little as $50 on the dark web.

KYC is an invaluable tool to help governments control money laundering, but only creates the illusion of protecting exchanges against fraud. In reality, it allows more fraudulent transactions, while adding friction upstream that often discourages crypto investments by new users. The end result is lost business, heavy fraudulent chargebacks, and artificial barriers to the adoption of crypto by a wider population.  

In a typical scenario, Jennifer L., a 27-year-old account executive, read an article about Ethereum and wanted to test the crypto waters. She headed to Coinbase looking to purchase $20 worth of the currency. However, after adding her payment details, she was asked to submit a picture of the front and back of her driver’s license or passport. After submitting that, she was asked for a photo showing her holding her picture ID. Jennifer decided it wasn’t worth the effort for $20 of crypto, abandoned the purchase, and is unlikely to try again any time soon. Cryptocurrency exchanges see these types of abandoned carts all day, every day.    

Unfortunately, most payment systems automatically reject questionable customers. This hits new users the hardest, as they haven’t built up a trustworthy reputation within the payment system.

Every industry has an ecosystem of businesses and suppliers that rise and fall based on their performance, and the cryptocurrency market is no exception. Fewer investors mean a smaller market for publications, advertisers, investment counselors, and blockchain developers. There are also fewer opportunities to create new coins or technologies, develop marketing plans, and analyze the market.

Cryptocurrency can grow its market size, support a significantly more extensive ecosystem, and experience a golden age of innovation if it can find a way to expedite the onboarding of the millions of users who are being turned away due to fraud concerns. Reducing the need to use KYC beyond regulatory requirements, moving away from rule-based credit approval systems, and leveraging behavioral-based AI screening solutions would certainly help.

AI is capable of making accurate transaction approval decisions in a fraction of a second, making high-efficacy decisions in less than 300ms, fast enough to keep up with crypto purchases. It approves more first-time users while detecting and rejecting fraudulent users. When cryptocurrency exchanges move toward AI fraud detection, we will see the entire market reach its potential.