What is KYC and how does it work?

Maciej Zieliński

13 Apr 2022
What is KYC and how does it work?

KYC, the “Know Your Customer” rule, is a common method of user verification in connection with the start of said users use of financial services. KYC is the norm in cryptocurrencies and financial law, as professionals are required to make every effort to verify the identity, relevance and risk of maintaining business relationships with the customer. These procedures are also a measure for AML analysis, which is taking action which aim to prevent money laundering. How does KYC work? In which countries must NFT projects implement the KYC procedure? What does it require of us? We're writing about this below.

How does KYC work?

KYC processes are also used by various economic operators to ensure that their customers, agents or consultants are checked before they are given access to any financial resources. The “Know Your Client” principle (KYC) is a mandatory requirement for entities which deal with securities, bank accounts, etc.

What is included in KYC

The purpose of the provisions set out by the KYC is to prevent criminals from using businesses for money laundering and commiting other financial crimes. By linking KYC and AML, many companies understand their customers better and have the opportunity to verify the capital and payments they receive. This helps them manage risk responsibly and professionally. In principle, institutions formulate their KYC policies on the basis of the following four key elements:

  • Customer Acceptance Policy
  • Customer Identification Procedures,
  • Monitoring of Transactions,
  • Risk Management.

The financial law environment is quite rigorous and makes KYC a mandatory and key procedure for financial institutions and others, as KYC minimizes the risk of fraud by identifying suspicious information at the initial stage of account creation. The KYC policy defines a client as follows. A customer is:

  • the person or entity that holds the account or is in a business relationship with the reporting entity;
  • the person on whose behalf the account is held,
  • the beneficiary of transactions carried out by professional intermediaries, such as exchange brokers, auditors or legal advisers,
  • any person or entity associated with a financial transaction that may pose a significant reputational risk or other risk to a bank, i.e. a person performing a bank transfer or issuing a “trust” on a high-value request as a single transaction.


In NFT, KYC is an element that is dependent on a given country’s policies, but also on what type of NFT will be used. Each State decides on its own whether the creation of NFT requires implementation of KYC procedures. Below we present the most popular places in the world of cryptography, which we have systematized by legislation.

Dane, Bezpieczeństwo, Klawiatura, Komputer, Laptop

KYC and cryptocurrencies

Cryptocurrencies are seen as decentralized and anonymous funds. However, these benefits are also a challenge in preventing money laundering, as criminals see cryptocurrencies as an ideal means of using illegal capital. As a result, many financial institutions are looking for ways to impose KYC on cryptocurrency markets, requiring cryptocurrency platforms to verify their clients. Currently, most of the entities have implemented or are implementing KYC into their services. Exchanges are classified in accounting terms as “crypto-to-crypto” or “fiat-to-crypto”. As crypto-crypto exchanges do not deal with traditional currency, they do not feel the same pressure to apply KYC standards as stock exchanges which store traditional currency of any sort. If stock exchanges have a traditional currency in their offer, they are more pressured by states to implement the KYC rule. Countries which show great interest in NFT have already regulated this area. The United Arab Emirates, Estonia, Switzerland and the United Kingdom are places worth familiarizing yourself with if you want to start your NFT journey.

Dubai and NFT

At present, crypto assets in the United Arab Emirates have not been classified for their purpose, which could help to determine the law in this respect. Instead, the United Arab Emirates recognizes that it is necessary to specify how cryptocurrencies or NFT are actually used. For example, a crypto resource can be used as a token of use (in this case it will not be regulated as a financial product and it is probably not necessary to implement KYC), but with an awareness of its popularity it is considered to be traded for the purpose of making an investment. If, according to the country, the NFT is seen as a means of investment, it is an investment product, then it will be treated as a financial product, resulting in its regulation using the provisions regarding UAE securities (in this case, KYC needs to be implemented in the project). In Dubai and the United Arab Emirates, there is no single law which regulates NFT. Any use of NFT is analyzed in terms of its actual use. Although Abu Dhabi Global market (ADGM) as a free financial zone regulated the use of crypto assets as virtual assets, NFT does not fall within this definition. According to this law, “the virtual resource is not produced or guaranteed by any jurisdiction”. In summary, it should be pointed out that NFT is subject to KYC only if it is practically treated as an investment project. NFT is not subject to KYC if it is treated as a token of use only.

NFT and KYC in Estonia

Until 2020, it appeared that cryptocurrencies can enjoy freedom in Estonia in terms of legal regulation. This country has become the ideal place for businesses and business professionals who wanted to legally run a business based on blockchain technology and cryptocurrencies. The license issued by Estonia also provides the possibility to provide services throughout the EU. Do you need to obtain a license to implement your NFT project in Estonia? As a general rule, not until 2020! This was due to the fact that licenses were mandatory for virtual currency service providers. The law in this case describes virtual currencies as payment-based instruments such as Ether (ETH), Bitcoin (BTC), USDT and others.
According to case-law, the NFT did not cover the definition of virtual currencies, since each NFT provides a unique, limited or documented resource that allows for the use of specific items such as digital art. NFT is treated more as a property right, rather than a means of payment. That was the case in the past, but the 2020 amendment on the legislation
regarding anti-money laundering put all entities connected with NFT, ICO and decentralized exchanges into one group. Since then, KYC is a mandatory component in the implementation of NFT projects.

Switzerland – NFT are not securities

The situation in Switzerland is similar to that in the United Arab Emirates. When NFT is used as a means of payment and can be transferred or reinvested, the regulatory authority is required to implement KYC and AML procedures. If the NFT does not belong to the securities category and serves only as a guarantee of the “right of access” to the service or digital arts, there is no mandatory obligation to implement KYC and AML procedures. However, if the NFT can in any way be used as an investment, it is subject to the definition of securities.

Great Britain – mandatory compliance with KYC standards

In the UK, the procedural requirements determining whether the creation of a NFT project requires the implementation of the KYC and AML regulations were created by the RUSI (Royal United Services Institute), the UK's defense and security think tank. The institution itself was created in 1831 and is intended to ensure the security and efficient operation of the country’s finances. According to RUSI, NFT products:

  • help guarantee an ownership record of any item by means of a digital element,
  • give creators the ability to obtain royalties from copyrights,
  • are mainly purchased using cryptocurrencies.

Unfortunately, RUSI points to the risks associated with NFT, which it defines as follows:

  • NFT is purchased using cryptocurrencies, which are often used to commit financial crimes or for money laundering.
  • There is a risk of hacking attacks on accounts of users who own NFT.
  • As such, RUSI identifies NFT as a product that requires both KYC and AML procedures to be implemented and followed.


With KYC, we gain the ability to collect and analyze a lot of customer information. This helps protect them from financial crime and facilitates the exchange of information between companies and users. In addition, KYC is an aid to AML, as at an early stage it can identify an entity that is likely to be criminogenic. As countries are increasingly concerned about the bureaucracy and regulation of each sector, KYC is an element that everyone will need to familiarize themselves with sooner or later. Let us remember that NFT may have different applications, from collectors' products to gaming, or property rights to invest. Depending on their use, as well as the geographical and legislative elements, different provisions will apply. At the same time, we stress that it is useful to consult a professional legal adviser to help you comply with applicable laws before any actions connected with KYC, AML, or NFT are taken. This article does not constitute legal advice.

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Applying Game Theory in Token Design

Kajetan Olas

16 Apr 2024
Applying Game Theory in Token Design

Blockchain technology allows for aligning incentives among network participants by rewarding desired behaviors with tokens.
But there is more to it than simply fostering cooperation. Game theory allows for designing incentive-machines that can't be turned-off and resemble artificial life.

Emergent Optimization

Game theory provides a robust framework for analyzing strategic interactions with mathematical models, which is particularly useful in blockchain environments where multiple stakeholders interact within a set of predefined rules. By applying this framework to token systems, developers can design systems that influence the emergent behaviors of network participants. This ensures the stability and effectiveness of the ecosystem.

Bonding Curves

Bonding curves are tool used in token design to manage the relationship between price and token supply predictably. Essentially, a bonding curve is a mathematical curve that defines the price of a token based on its supply. The more tokens that are bought, the higher the price climbs, and vice versa. This model incentivizes early adoption and can help stabilize a token’s economy over time.

For example, a bonding curve could be designed to slow down price increases after certain milestones are reached, thus preventing speculative bubbles and encouraging steadier, more organic growth.

The Case of Bitcoin

Bitcoin’s design incorporates game theory, most notably through its consensus mechanism of proof-of-work (PoW). Its reward function optimizes for security (hashrate) by optimizing for maximum electricity usage. Therefore, optimizing for its legitimate goal of being secure also inadvertently optimizes for corrupting natural environment. Another emergent outcome of PoW is the creation of mining pools, that increase centralization.

The Paperclip Maximizer and the dangers of blockchain economy

What’s the connection between AI from the story and decentralized economies? Blockchain-based incentive systems also can’t be turned off. This means that if we design an incentive system that optimizes towards a wrong objective, we might be unable to change it. Bitcoin critics argue that the PoW consensus mechanism optimizes toward destroying planet Earth.

Layer 2 Solutions

Layer 2 solutions are built on the understanding that the security provided by this core kernel of certainty can be used as an anchor. This anchor then supports additional economic mechanisms that operate off the blockchain, extending the utility of public blockchains like Ethereum. These mechanisms include state channels, sidechains, or plasma, each offering a way to conduct transactions off-chain while still being able to refer back to the anchored security of the main chain if necessary.

Conceptual Example of State Channels

State channels allow participants to perform numerous transactions off-chain, with the blockchain serving as a backstop in case of disputes or malfeasance.

Consider two players, Alice and Bob, who want to play a game of tic-tac-toe with stakes in Ethereum. The naive approach would be to interact directly with a smart contract for every move, which would be slow and costly. Instead, they can use a state channel for their game.

  1. Opening the Channel: They start by deploying a "Judge" smart contract on Ethereum, which holds the 1 ETH wager. The contract knows the rules of the game and the identities of the players.
  2. Playing the Game: Alice and Bob play the game off-chain by signing each move as transactions, which are exchanged directly between them but not broadcast to the blockchain. Each transaction includes a nonce to ensure moves are kept in order.
  3. Closing the Channel: When the game ends, the final state (i.e., the sequence of moves) is sent to the Judge contract, which pays out the wager to the winner after confirming both parties agree on the outcome.

A threat stronger than the execution

If Bob tries to cheat by submitting an old state where he was winning, Alice can challenge this during a dispute period by submitting a newer signed state. The Judge contract can verify the authenticity and order of these states due to the nonces, ensuring the integrity of the game. Thus, the mere threat of execution (submitting the state to the blockchain and having the fraud exposed) secures the off-chain interactions.

Game Theory in Practice

Understanding the application of game theory within blockchain and token ecosystems requires a structured approach to analyzing how stakeholders interact, defining possible actions they can take, and understanding the causal relationships within the system. This structured analysis helps in creating effective strategies that ensure the system operates as intended.

Stakeholder Analysis

Identifying Stakeholders

The first step in applying game theory effectively is identifying all relevant stakeholders within the ecosystem. This includes direct participants such as users, miners, and developers but also external entities like regulators, potential attackers, and partner organizations. Understanding who the stakeholders are and what their interests and capabilities are is crucial for predicting how they might interact within the system.

Stakeholders in blockchain development for systems engineering

Assessing Incentives and Capabilities

Each stakeholder has different motivations and resources at their disposal. For instance, miners are motivated by block rewards and transaction fees, while users seek fast, secure, and cheap transactions. Clearly defining these incentives helps in predicting how changes to the system’s rules and parameters might influence their behaviors.

Defining Action Space

Possible Actions

The action space encompasses all possible decisions or strategies stakeholders can employ in response to the ecosystem's dynamics. For example, a miner might choose to increase computational power, a user might decide to hold or sell tokens, and a developer might propose changes to the protocol.

Artonomus, Github

Constraints and Opportunities

Understanding the constraints (such as economic costs, technological limitations, and regulatory frameworks) and opportunities (such as new technological advancements or changes in market demand) within which these actions take place is vital. This helps in modeling potential strategies stakeholders might adopt.

Artonomus, Github

Causal Relationships Diagram

Mapping Interactions

Creating a diagram that represents the causal relationships between different actions and outcomes within the ecosystem can illuminate how complex interactions unfold. This diagram helps in identifying which variables influence others and how they do so, making it easier to predict the outcomes of certain actions.

Artonomus, Github

Analyzing Impact

By examining the causal relationships, developers and system designers can identify critical leverage points where small changes could have significant impacts. This analysis is crucial for enhancing system stability and ensuring its efficiency.

Feedback Loops

Understanding feedback loops within a blockchain ecosystem is critical as they can significantly amplify or mitigate the effects of changes within the system. These loops can reinforce or counteract trends, leading to rapid growth or decline.

Reinforcing Loops

Reinforcing loops are feedback mechanisms that amplify the effects of a trend or action. For example, increased adoption of a blockchain platform can lead to more developers creating applications on it, which in turn leads to further adoption. This positive feedback loop can drive rapid growth and success.

Death Spiral

Conversely, a death spiral is a type of reinforcing loop that leads to negative outcomes. An example might be the increasing cost of transaction fees leading to decreased usage of the blockchain, which reduces the incentive for miners to secure the network, further decreasing system performance and user adoption. Identifying potential death spirals early is crucial for maintaining the ecosystem's health.

The Death Spiral: How Terra's Algorithmic Stablecoin Came Crashing Down
the-death-spiral-how-terras-algorithmic-stablecoin-came-crashing-down/, Forbes


The fundamental advantage of token-based systems is being able to reward desired behavior. To capitalize on that possibility, token engineers put careful attention into optimization and designing incentives for long-term growth.


  1. What does game theory contribute to blockchain token design?
    • Game theory optimizes blockchain ecosystems by structuring incentives that reward desired behavior.
  2. How do bonding curves apply game theory to improve token economics?
    • Bonding curves set token pricing that adjusts with supply changes, strategically incentivizing early purchases and penalizing speculation.
  3. What benefits do Layer 2 solutions provide in the context of game theory?
    • Layer 2 solutions leverage game theory, by creating systems where the threat of reporting fraudulent behavior ensures honest participation.

Token Engineering Process

Kajetan Olas

13 Apr 2024
Token Engineering Process

Token Engineering is an emerging field that addresses the systematic design and engineering of blockchain-based tokens. It applies rigorous mathematical methods from the Complex Systems Engineering discipline to tokenomics design.

In this article, we will walk through the Token Engineering Process and break it down into three key stages. Discovery Phase, Design Phase, and Deployment Phase.

Discovery Phase of Token Engineering Process

The first stage of the token engineering process is the Discovery Phase. It focuses on constructing high-level business plans, defining objectives, and identifying problems to be solved. That phase is also the time when token engineers first define key stakeholders in the project.

Defining the Problem

This may seem counterintuitive. Why would we start with the problem when designing tokenomics? Shouldn’t we start with more down-to-earth matters like token supply? The answer is No. Tokens are a medium for creating and exchanging value within a project’s ecosystem. Since crypto projects draw their value from solving problems that can’t be solved through TradFi mechanisms, their tokenomics should reflect that. 

The industry standard, developed by McKinsey & Co. and adapted to token engineering purposes by Outlier Ventures, is structuring the problem through a logic tree, following MECE.
MECE stands for Mutually Exclusive, Collectively Exhaustive. Mutually Exclusive means that problems in the tree should not overlap. Collectively Exhaustive means that the tree should cover all issues.

In practice, the “Problem” should be replaced by a whole problem statement worksheet. The same will hold for some of the boxes.
A commonly used tool for designing these kinds of diagrams is the Miro whiteboard.

Identifying Stakeholders and Value Flows in Token Engineering

This part is about identifying all relevant actors in the ecosystem and how value flows between them. To illustrate what we mean let’s consider an example of NFT marketplace. In its case, relevant actors might be sellers, buyers, NFT creators, and a marketplace owner. Possible value flow when conducting a transaction might be: buyer gets rid of his tokens, seller gets some of them, marketplace owner gets some of them as fees, and NFT creators get some of them as royalties.

Incentive Mechanisms Canvas

The last part of what we consider to be in the Discovery Phase is filling the Incentive Mechanisms Canvas. After successfully identifying value flows in the previous stage, token engineers search for frictions to desired behaviors and point out the undesired behaviors. For example, friction to activity on an NFT marketplace might be respecting royalty fees by marketplace owners since it reduces value flowing to the seller.

source: https://www.canva.com/design/DAFDTNKsIJs/8Ky9EoJJI7p98qKLIu2XNw/view#7

Design Phase of Token Engineering Process

The second stage of the Token Engineering Process is the Design Phase in which you make use of high-level descriptions from the previous step to come up with a specific design of the project. This will include everything that can be usually found in crypto whitepapers (e.g. governance mechanisms, incentive mechanisms, token supply, etc). After finishing the design, token engineers should represent the whole value flow and transactional logic on detailed visual diagrams. These diagrams will be a basis for creating mathematical models in the Deployment Phase. 

Token Engineering Artonomous Design Diagram
Artonomous design diagram, source: Artonomous GitHub

Objective Function

Every crypto project has some objective. The objective can consist of many goals, such as decentralization or token price. The objective function is a mathematical function assigning weights to different factors that influence the main objective in the order of their importance. This function will be a reference for machine learning algorithms in the next steps. They will try to find quantitative parameters (e.g. network fees) that maximize the output of this function.
Modified Metcalfe’s Law can serve as an inspiration during that step. It’s a framework for valuing crypto projects, but we believe that after adjustments it can also be used in this context.

Deployment Phase of Token Engineering Process

The Deployment Phase is final, but also the most demanding step in the process. It involves the implementation of machine learning algorithms that test our assumptions and optimize quantitative parameters. Token Engineering draws from Nassim Taleb’s concept of Antifragility and extensively uses feedback loops to make a system that gains from arising shocks.

Agent-based Modelling 

In agent-based modeling, we describe a set of behaviors and goals displayed by each agent participating in the system (this is why previous steps focused so much on describing stakeholders). Each agent is controlled by an autonomous AI and continuously optimizes his strategy. He learns from his experience and can mimic the behavior of other agents if he finds it effective (Reinforced Learning). This approach allows for mimicking real users, who adapt their strategies with time. An example adaptive agent would be a cryptocurrency trader, who changes his trading strategy in response to experiencing a loss of money.

Monte Carlo Simulations

Token Engineers use the Monte Carlo method to simulate the consequences of various possible interactions while taking into account the probability of their occurrence. By running a large number of simulations it’s possible to stress-test the project in multiple scenarios and identify emergent risks.

Testnet Deployment

If possible, it's highly beneficial for projects to extend the testing phase even further by letting real users use the network. Idea is the same as in agent-based testing - continuous optimization based on provided metrics. Furthermore, in case the project considers airdropping its tokens, giving them to early users is a great strategy. Even though part of the activity will be disingenuine and airdrop-oriented, such strategy still works better than most.

Time Duration

Token engineering process may take from as little as 2 weeks to as much as 5 months. It depends on the project category (Layer 1 protocol will require more time, than a simple DApp), and security requirements. For example, a bank issuing its digital token will have a very low risk tolerance.

Required Skills for Token Engineering

Token engineering is a multidisciplinary field and requires a great amount of specialized knowledge. Key knowledge areas are:

  • Systems Engineering
  • Machine Learning
  • Market Research
  • Capital Markets
  • Current trends in Web3
  • Blockchain Engineering
  • Statistics


The token engineering process consists of 3 steps: Discovery Phase, Design Phase, and Deployment Phase. It’s utilized mostly by established blockchain projects, and financial institutions like the International Monetary Fund. Even though it’s a very resource-consuming process, we believe it’s worth it. Projects that went through scrupulous design and testing before launch are much more likely to receive VC funding and be in the 10% of crypto projects that survive the bear market. Going through that process also has a symbolic meaning - it shows that the project is long-term oriented.

If you're looking to create a robust tokenomics model and go through institutional-grade testing please reach out to contact@nextrope.com. Our team is ready to help you with the token engineering process and ensure your project’s resilience in the long term.


What does token engineering process look like?

  • Token engineering process is conducted in a 3-step methodical fashion. This includes Discovery Phase, Design Phase, and Deployment Phase. Each of these stages should be tailored to the specific needs of a project.

Is token engineering meant only for big projects?

  • We recommend that even small projects go through a simplified design and optimization process. This increases community's trust and makes sure that the tokenomics doesn't have any obvious flaws.

How long does the token engineering process take?

  • It depends on the project and may range from 2 weeks to 5 months.