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It seems like one of the ways exchanges are beefing up security is by making everyone submit tons of verification documents in order to do anything

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No, that's about complying with Know Your Customer and Anti-Money Laundering laws so they are committing fewer felonies.

But honestly, that kind of verification is going to cut into a big chunk of the userbase. Nobody wants to submit 3 different forms of ID to buy some drugs or launder some money.

ID or not, it’s not a particularly smart idea to run illegal transactions through a system that records those transactions in a redundantly backed up and publicly viewable distributed database.

That's why tumblers exist.

More insidiously, if you're level N verified then the exchange will probably tell you that you need to be level N+1 verified to withdraw any of your money.

But no amount of identity verification can prevent exchanges from being hacked or from defrauding their own customers.

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