KYC for

OTC Desks
 Contents
OTC Trading Landscape 1

OTC Trading: Risks 2

How is KYC currently performed by OTC desks? 4

Challenges of implementing KYC for OTC Desks 5

Benefits of implementing KYC for OTC desks 6

Case Study: Satoshi Deals 8

Final Thoughts 9

About KYC-Chain 10
1 OTC Trading Landscape

Over-the-counter (OTC) trading involves trading securities such as equity, derivatives, debt
instruments and other alternative assets directly between buyers and sellers - in short, it refers to
direct trading in securities between owners and sellers.

In practice, most OTC transactions are carried out between investors and OTC desks that act as a
buyer or seller.

More recently, OTC trading has gained popularity as a means to trade cryptocurrencies
independently of centralized exchanges.

The crypto OTC market has emerged as an attractive investment conduit for various different actors
- from hedge funds to smaller asset managers, family offices, High-net-worth Individuals (HNWIs) and
accredited investors - due to several key advantages it holds over exchange-based trading.

These include:

• Higher or non-existent caps on trading volumes

• Greater anonymity and price protection
• Avoidance of sudden price fluctuations during a transaction (known as “slippage”)
• Preventing fluctuations in market prices through increased supply and demand as a result of
making an order. Prices can be agreed on prior to the transaction.

The OTC market is growing as more and more institutional and private investors seek to increase the
weight of crypto in their portfolios. However, due to the largely private nature of the space, it can be
hard to accurately estimate its market capitalization.

In 2018, Bloomberg reported that the OTC market ranged from a daily trading volume of between
US$250 million and US$30 billion - a substantial range. As the crypto market has grown significantly in
value since then, the current volumes are likely far higher.

As such, OTC desks – which effectively act as a dealer that buys and sells crypto from businesses and
individuals that want to avoid exchanges – have proliferated.

However, OTC trading does come with various risks (and opportunities) when compared to
centralized exchange trading. This applies to both individuals and businesses carrying out OTC
transactions - and the OTC desks themselves.

This guide will outline what those risks are – and how they can be mitigated with effective,
automated Know Your Customer (KYC) and Know Your Business (KYB) processes both for buyers and
sellers using OTC desks.

KYC for OTC Desks 1

2 OTC Trading: Risks

While OTC trading certainly carries several benefits - in particular for buyers and sellers who trade
large volumes of crypto – it also presents some very serious risks.

In simple terms, trading through an OTC desk does not provide the same kinds of assurances and
failsafes that exchanges provide (though as anyone who has been even superficially following the
crypto market will know, exchanges are also not immune to hacks and fraud).

OTC desks themselves are also vulnerable to fraud as they also need to engage in transactions with
buyers and sellers.

Key risks of OTC trading include (but are not limited to):

1. Sellers not having – or not actually intending on

selling – the crypto that buyers agree to pay for
One of the biggest scams that is carried out through OTC trading is where a seller claims to have the
cryptocurrency that a buyer wants to purchase, when in fact they do not actually possess the crypto -
or have no intention of actually selling it.

The buyer will be led to believe that they are sending the funds to a party that owns a certain amount
of crypto, usually by the alleged seller sending a video or screenshot of the contents of their wallet.
Sometimes, when OTC crypto trades take place at a bank or apparently neutral location, a cold stor-
age wallet will be provided to the mediating party, which will not properly check it for the cryptocur-
rency, before passing it on to the buyer.

Buyers can fall victim to this kind of fraud if they do not effectively check that the wallet the seller
claims to own actually contains the crypto they are looking to purchase. In order to verify that a wallet
in fact belongs to the seller they are dealing with, buyers should request that the seller send a
message to them from the wallet address with a customized message, such as their two names or
nicknames.

Sellers that insist on just providing video or image proof of their wallet address should not be trusted,
as such visual evidence can be easily obtained online.

2. Refund fraud
This kind of scam can also affect ICO issuers, and is a risk that is usually carried by sellers. A buyer will
essentially make the purchase of the cryptocurrency, receive the coins and then request a refund on
the transaction from the bank by claiming that they were not aware of the purchase.

KYC for OTC Desks 2

In such an instance, certain banks are obliged to make the refund, reversing the transaction.
However, as banks are generally not able to trace and then force the cryptocurrency to be returned,
the buyer remains in possession of the effectively stolen crypto.

3. Vague contracts
Ambiguous contracts between buyers and sellers can lead to a wide and constantly expanding range
of different scams. For large transactions, it’s incredibly important to have a trusted legal professional
review a contract that is proposed by either counterparty.

Each party’s lawyers should be able to verify that the contract has enough level of detail and is legally
binding. Typos and vague language in a contract should be a major red flag.

4. Double spending
Another, especially sophisticated scam that can affect OTC trades, double spending involves a buyer
or a seller pretending to send the funds or crypto to an address during a real-time exchange, when
in fact an associate of theirs is manipulating the blockchain to send the same digital token to another
address.

Most of the risks of OTC trading are carried by buyers, though sellers are
also victims of fraud.

Crypto exchanges are able to mitigate many of the risks of OTC trading
through the use of trustless systems. There is no need for two parties in a
transaction to actually trust each other, because the crypto exchange acts
as a middleman, buying from the seller and selling to the buyer.

With OTC trading, there is a need for a certain level of trust between buyer
and seller. And this is where KYC comes in - it’s impossible to trust someone
if you don’t know who they are.

KYC for OTC Desks 3

3 How is KYC currently performed
by OTC desks?

Buyers and sellers conducting OTC trades usually

perform manual KYC checks on each other.
However, the process is far from uniform across the
space.

Buyers and sellers also typically carry out KYC checks

that include:

• Verifications of buyers’ bank account ownership

• Carrying out checks to ensure that a seller truly

controls the wallet they claim to be selling the
cryptocurrency from

• Confirmation of addresses of counterparties in

order to have an avenue to pursue legal action,
should the need arise

• Requesting and collecting documents for

verification manually via email - which is highly time
consuming

However, because the onus is on each party to

ascertain and confirm the identity of the
counterparty, using manual and non-systematic
processes means that there is plenty of room for
risks to enter the fray.

KYC for OTC Desks 4

4 Challenges of implementing KYC
for OTC Desks

OTC desks are faced with a tough challenge: maintaining client privacy while also ensuring that
counterparties are who they say they are in order to mitigate the possibility of fraud and other
financial crimes.

While OTC desks may attempt to carry out

their own KYC checks on counterparties
manually, there are complexities in doing
so effectively. The problem with this
approach is that it is:

• Time-intensive
• Resource-intensive
• Easily inconsistent
• Hard to carry out across a
comprehensive range of jurisdictions

Effective KYC and KYB processes need to

be able to have multi-jurisdictional
coverage in order to be able to:

• Adequately assess the authenticity of

an individual’s provided identity
• Check a corporate counterparty’s
articles of incorporation and
regulatory status
• Understand the solvency status of
corporate and individual
counterparties
• Evaluate the risk profile of foreign
individuals and entities, including their
presence on international
watchlists and sanctions lists

Depending on the amount of transactions an OTC is engaging with on a daily, weekly, and monthly
basis, manually carrying out all of these checks efficiently and accurately may simply be unfeasible -
and also impractical.

KYC for OTC Desks 5

5 Benefits of implementing KYC
for OTC desks

OTC desks can overcome transactional and regulatory risks - as well as the challenges of conducting
manual KYC - by implementing an automated KYC solution.

An automated KYC workflow can be seamlessly integrated in an OTC desk’s onboarding process. This
can effectively carry out comprehensive checks on counterparties that can confirm their identities and
risk profiles.

Automated KYC for OTC desks will go through the following steps:

1. ID Document / Certificate of Incorporation

Scanning uploaded identity documents for visual authenticity, image integrity, and document data
validation. This can use advanced technologies such as algorithmic and digital tampering detection.

For businesses: checking registration number or legal name against government registries across
global jurisdictions. Once authenticated, compliance teams can confirm their registration and status
with corporate registries.

For individuals: Optical Character Recognition (OCR) Extraction can automatically extract data from
identity documents and images uploaded by users. This information is then cross referenced with
verified data stored on government registries and other public databases.

KYC for OTC Desks 6

2. Passive Liveness Checks
A relatively new process that is able to verify whether an individual taking part in an onboarding
process is in fact the individual being presented in an uploaded selfie image or video - and not an
imposter or fabrication.

3. AML Screening
Checking an onboarded individual or entity name against a comprehensive selection of global
watchlists that include sanctioned entities, Politically Exposed Persons (PEPs), and references in
adverse media.

4. Crypto Wallet Screening

For OTC trading desks, understanding the history of a wallet, as well as other key credentials, is a
critical step for mitigating the risk that it is a conduit for money laundering and other financial crimes.

5. Jurisdiction Assessment
Many OTCs need to restrict access to counterparties from certain countries and jurisdictions for
different reasons - from complying with global sanctions to tax purposes and avoiding certain
regulatory regimes. A robust automated KYC process will be able to filter eligible counterparties
according to where they are based, or where their main place of business is.

6. Risk Scoring
Once an individual or corporate customer’s identity and credentials have been established, an
automated KYC tool will assign a risk score to that investor. This score will then inform a decision on
whether to automatically grant that counterparty access to the OTC desk, apply further checks and
scrutiny, or to reject them.

7. Enhanced Due Diligence (EDD)

For potential counterparties that have been flagged as a potential risk, EDD processes can be applied
that do not necessarily require human intervention from compliance teams. However, many KYC
automation tools do also provide customizable options for high-risk subjects to be forwarded to a
compliance team, ensuring that restrictions on investment are checked and justified.

KYC for OTC Desks 7

6 Case Study: Satoshi Deals

OTC Desks are already optimizing their compliance processes by using KYC-Chain.

One such company is Satoshi Deals, a financial services firm that offers peer-to-peer trading and
custodial services to their HNWI and institutional clients.

Last year, Satoshi Deals integrated KYC-Chain’s end-to-end workflow solution on their platform.
One of the key prerequisites for the Cyprus-based company was to have a KYC solution that
complemented their highly intuitive and user-friendly interface - and did not add extra or
unnecessary burden on their clients.

Before implementing KYC-Chain, Satoshi Deals faced the following challenges in carrying out
their KYC:

1. Running paper-based KYC/AML on their individual clients.

2. An urgent need for crypto wallet checks, as banks are now overwhelmingly requiring them as a
required compliance credential.

3. They were looking for a way to digitize their entire onboarding process – both frontend and
backend - to have a more complete solution.

KYC-Chain was able to tailor a solution for Satoshi Deals that included bespoke solutions and
features that addressed these issues, such as:

• Live API integrations to government databases with real-time data updates every 24 hours.

• Validation of company data for 105 different countries covering over 160m companies and data
checks from over 10,000 data source points.

• Algorithmic and anti-tampering validity checks that provide a 40-point likeliness score to spot
fake pictures and documents.

• Flexibility to create custom templates and define questions and documents as needed for a
specific process.

• Digitally approve or reject each application when all relevant processes are complete.

• Significantly reduced client onboarding times.

KYC for OTC Desks 8

7 Final Thoughts

OTC Trading has emerged as a powerful system for

crypto buyers and sellers to realize numerous
benefits over exchange-based transactions, in
particular when it comes to large-volume trades. As
such, the space continues to expand, driven by OTC
trading desks’ offer of higher or non-existent caps
on trading volumes, greater anonymity, avoidance of
‘slippage’ and more.

Nevertheless, the benefits offered by OTC trading

are somewhat counterbalanced by the risks
involved, which include fraudulent and/or scam
transactions that can affect both buyers and sellers.

The root cause of most risks carried by OTC trading

are related to the lack of adequate and effective KYC
measures being implemented on traders. OTC
trading desks can effectively counter OTC trading
risks, ensure compliance with global regulations and
build trust among their client base by
implementing effective and efficient Automated KYC.

By intelligently adopting new technologies that

optimize compliance processes and reduce fraud
risks, OTC trading desks can fortify their position in
the brave new world of decentralization and pave
the way for scalable and responsible growth.

KYC for OTC Desks 9

8 About KYC-Chain

KYC-Chain is a compliance dashboard and whitelabel customer on-boarding portal

enabling companies to perform due diligence on their customers in accordance with
CDD/AML/KYC requirements.

KYC-Chain enables automated on-boarding of people and legal entities by leveraging

technology such as robotic process automation, biometric matching neural networks,
and blockchain based identity credentials.

Our solutions provide KYC on-boarding that is quick, easy, and for both corporates
and individuals, in a blockchain enabled financial world.

Have any questions on how to comply with KYC and AML regulations for your OTC
desk?

Get in touch and we’ll be happy to arrange a demo.

KYC for OTC Desks 10

kyc-chain.com • [email protected]