What is KYC and How It Works: The Essence of Modern Personal Identification Systems

Trust has become the foundation of any organization's activities, particularly on the internet. Any interaction between a client and a company, platform, financial institution, cryptocurrency exchange, or other organizations does not begin with direct cooperation, but with user identification. This is precisely the function that KYC performs.

What is KYC

According to the financial portal Investopedia, KYC (Know Your Customer) is a set of regulatory and technological procedures that various organizations use to verify and confirm the identity of their clients, assess risk levels, and identify signs of suspicious activity. It is the primary tool for meeting regulatory requirements.

This is confirmed by Mike Slaugh, a leading information systems engineer at Amazon Business, in an interview for Identity Week:

Financial services, with their rigorous 'Know Your Customer' standards, offer valuable lessons for e-commerce. Borrowing those verification techniques can help Amazon and others better understand their customers, tailor experiences, and strengthen protection at scale

According to Mike Slaugh, Amazon itself views authentication as a continuous process rather than a one-time event:

Everything begins with verifying the user's identity upon login, but risk assessment is conducted throughout the entire session, monitoring unusual behavior or signals to maintain constant confidence in the user's identity

In simple terms, KYC is a continuous process that helps a company answer the question: "Who is this person, and can we trust them?"

Primary Tasks of KYC Verification:

• Identification and verification of the client's identity based on their data
• Ensuring compliance with global regulatory requirements
• Reducing fraud risks
• Identifying potentially illegal transactions (money laundering, terrorism financing)

Types of KYC: Traditional, Electronic, and Hybrid

In practice, KYC is used in three main formats depending on the organization, degree of risk, and regulatory requirements.

1. Traditional (Offline) KYC

Offline KYC is a basic, initial identification model characterized by the client's personal presence at a company's branch. Under this system, an organization's employee manually checks documents, asks questions, and completes forms.

This format is still partially used in banks and organizations with physical locations.

Advantages:

• Offline format prevents the application of modern fraud methods based on digital tools (deepfakes, document forgery through digital channels)

Disadvantages:

• Low scalability and high operational costs
• Inability to serve remote clients
• Lengthy application processing times
• Manual errors and rejection of potentially successful applications

2. eKYC (Electronic KYC)

According to a Reconnaissance report, a revolution is occurring in document protection: society is transitioning from using physical documents, such as banknotes and identity cards, to using smartphones and electronic payment cards for financial transactions and as carriers of identification data. As a result, the traditional KYC system has been transformed into eKYC—a fully automated digital version of the traditional KYC identification process, whereby a client undergoes verification remotely through a mobile application or web platform.

eKYC is not a separate regulatory requirement but rather a method of digital implementation of KYC, based on artificial intelligence and machine learning. However, as Mike Slaugh, a leading information systems engineer at Amazon Business,notes, AI is equally both a tool for creating attacks and a weapon for countering them. Amazon itself, according to Mike Slaugh, uses AI to detect anomalies in massive data sets and identify various fraud schemes with its help.

During electronic KYC verification, documents (identification, driver's licenses, etc.) are used, as well as a selfie taken by the user in real time. The online identification format often includes biometric verification of the user's identity.

Advantages:

• Scalability — simultaneous processing of thousands of clients
• Availability 24/7 from any location with internet access
• Reduction of operational costs by 60-90%
• Minimal employee involvement — reducing manual errors and increasing conversion rates

Disadvantages:

• Requires internet and smartphone access
• Without proper protection mechanisms against modern attacks, the eKYC system can be vulnerable to digital fraud methods

3. Hybrid KYC

Hybrid KYC is a combination of automated electronic systems and manual verification from traditional methods.

This type of verification is used when the eKYC algorithm is uncertain about the result it has produced. In this case, the decision is made jointly by the system and a compliance specialist —a qualified employee manually reviews the unusual case and makes the final decision.

Scenarios for applying the hybrid approach:

• The eKYC system returns a high-risk result (for example, the client is on a sanctions list)
• The user's "liveness" percentage is not sufficiently high (<95%)
• The document being checked is damaged, blurry, or contains additional elements
• And others

KYC Structure: Components of the System

The KYC system consists of a stack of interconnected technologies united in a single decision-making chain. Each performs a specific function in the process of processing client information.

1. Document Recognition and Verification Module (Document Recognition)

The first step in a KYC system is the module responsible for document recognition and verification. It includes the following elements:

• Mobile app camera — a specialized interface for photographing documents with a hint function (shows the shooting area, checks lighting level, angle)
• OCR (Optical Character Recognition) — extraction of text data (full name, date of birth, document series and number)
• Document validation — checking format, checksums, compliance with ISO standards
• MRZ zone verification

2. Liveness Detection Module

The liveness detection module is one of the most important stages of the system, based on biometric verification. During the verification process, computer vision and machine learning are used to identify fraud and face substitution:

• Liveness Detection — a technology that confirms that a real person is behind the screen, not a printed photo or substituted image
• Anti-spoofing — protection against modern digital attacks (detects deepfakes, AI attacks, masks)

3. Face Comparison Module

Compares the client's selfie with their photograph in the document. Uses technologies:

• Deep neural networks (Deep Learning) to create a biometric face fingerprint
• Similarity score calculation between two images
• Accounting for age changes, makeup, hairstyle, and shooting angle

Face verification technology can significantly reduce fraud cases involving someone else's identity. For example, the first international trials of such a solution by dating platform Tinder showed a 60% reduction in fraud risk. Meanwhile, Yoel Roth, head of the Trust and Safety department at Match Group, Tinder's owner, reports:

Face Check is perhaps the most effective safety feature I've seen in my 15-year career

4. Sanctions Check Module (AML & CTF)

Verifies the presence of client data in sanctions lists:

• OFAC (Office of Foreign Assets Control) — US sanctions list
• EU Consolidated List — European Union sanctions list
• Sanctions lists of other countries
• International List of Organizations and Individuals Involved in Terrorist Activity (Consolidated Sanctions List of the UN Security Council)
• Databases of fraudsters and cybercriminals — including proprietary databases/blacklists of financial institutions and others

5. Risk Scoring Module

Calculates the overall risk rating based on multiple factors:

• Geographic factors (country of origin, territory of residence)
• Client age and activity history
• Document quality and system confidence level
• Behavioral signals (unusual activity patterns, rapid registration of multiple accounts)

6. Transaction Activity Analysis

KYC does not stop working after client registration. At subsequent stages, the system regularly rechecks user data. The criticality of post-analysis of users is also described by Christina Hulka, Executive Director of the Secure Technology Alliance:

Identity leaders have spent the last few years redefining what 'sign-in' really means. Authentication is no longer a front-door step that happens once, then fades into the background. It is increasingly a continuous, context-aware decision that determines what a user can do and what an attacker can attempt.

That shift matters beyond the identity stack because the highest value actions in digital life are not logins. They are transactions. Adding a card to a wallet, initiating a pay-out, changing account details or approving a high-risk purchase all force the same question: do we trust this user enough to move value right now?

As part of ongoing monitoring, the system constantly analyzes:

• Atypical activity
• Changes in behavioral profile
• Connections with high-risk addresses
• Transaction splitting
• Geographic anomalies

This component is closely linked with AML monitoring systems.

KYC Limitations

Despite its importance, the KYC system has certain boundaries that must be considered by industry participants. Depending on the chosen provider and their capabilities, a user may encounter the following obstacles:

1. Technological Limitations

• Camera and internet quality — if KYC technologies are not adapted for weak devices, blurry photos, poor lighting, or slow network speeds can lead to failed verifications
• Face recognition may work worse for certain ethnic groups if algorithm training was conducted on imbalanced datasets. According to a National Institute of Standards and Technology (NIST) study, face recognition accuracy can vary depending on the user group
• Vulnerability to deepfakes and synthesized videos — eKYC technologies need properly built protection mechanisms against modern attack methods
• Document format incompatibility — the document recognition system is trained on passports and driver's licenses from developed countries. Documents from lesser-known territories may be processed incorrectly if the provider's document database is initially small

2. Regulatory Limitations

• Different regulations in different countries — local laws of various countries require adaptation of the provider's technologies in the countries where their clients operate
• Consent requirements — the client must give explicit consent to the processing of biometric and personal data

3. Social and Ethical Limitations

• Financial exclusion — residents of some countries (especially developing ones) do not have current identification documents, which blocks access to financial services
• Privacy and trust — the collection and storage of biometric data raise client concerns about the security of their information. KYC identification provider technologies must comply with local personal data protection laws

4. Economic Limitations

• Operational costs of manual verification — despite automation, hybrid KYC requires at least a small team of experts to handle ambiguous cases
• Cost of false rejections — an improperly structured system may reject legitimate clients, leading to reputational and economic losses

5. Operational Limitations

• Dependence on third parties — the quality of KYC depends on the reliability of chosen providers
• Lagging behind fraudsters — with each passing day, new fraud methods emerge. As a result, the provider's continuous adaptation to new attack methods is critical

Conclusion

KYC is not simply a bureaucratic procedure but rather a strategic infrastructure that protects both the financial system and its participants. The evolution from classical offline-KYC to electronic and hybrid approaches reflects a balance between innovation, security, and accessibility.

However, no system is perfect. Existing limitations from technological to ethica require responsible choice of provider, cooperation between regulators and industry, as well as investments in research.

Organizations that understand both the capabilities and limitations of KYC will be able to more effectively use this technology to build trust with clients and comply with regulatory requirements in the global economy.