Unfortunately, there is always a criminal element looking to take advantage of things and money laundering and financing of illicit transactions are two consequences of such activities. With the evolution of more sophisticated technologies and increased globalization, the impact is astounding.
An article published in the International Banker (Nov 2017) titled, ‘The global impact of money laundering’, suggests that related transactions are, “estimated at 2 to 5% of global GDP — amounting to up to USD $2 trillion”. With the emergence of cryptocurrencies and the underlying blockchain technology, the impact is only likely to increase unless we find effective ways to combat these types of activity.
It is not surprising then, that regulators have also increased their attempts to stamp out this illicit activity through increased AML/CTF regulations. No one would argue that AML/CTF obligations are anything but necessary given the magnitude of illicit transactions and the rising threat of terrorism. It does, however, come at a cost to business, economies and ultimately customers. Whilst difficult to quantify, many sources quote direct global AML/CTF compliance spend as exceeding USD $8 billion in 2017, although a survey conducted that same year by LexisNexis, identified the cost of AML for European Financial service businesses to be USD $83.5 billion alone.
Whatever the actual cost globally, it is material and continues to rise. Add to this the cost of privacy obligations that go hand in hand with collecting and handling users data needed to complete compliance obligations and without a doubt, businesses are forced to divert significant capital which could otherwise be invested in the pursuit of growth, productivity and profitability to AML/CTF compliance.
Interestingly, studies also show that transaction monitoring systems continue to represent the greatest area of AML spending, “while satisfaction for these systems has declined with an average score of 3.42 out of 5 with regards to efficiency and effectiveness”.
Unfortunately, the spend on AML/CTF is not delivering results. In fact, “less than 1% of illicit financial flows are currently seized by authorities due to the complex nature of the activity”. The emergence of cryptocurrencies and blockchain technologies compound the inability of authorities to address this flow of illicit finances. This is largely due to the peer to peer nature of cryptocurrency transactions without a central intermediary facilitating transactions, the speed of which transactions are performed and most importantly, anonymity of users, which is one of the most engrained tenets of leading cryptocurrencies such as Bitcoin and platforms like Ethereum.
Existing AML systems and processes are not yet equipped to deal with these instruments. Furthermore, another contributing factor to the lack of effectiveness of current AML solutions is that they are largely independent, with each business developing their own systems and each jurisdiction having its own policies and rules. With the escalation of cross border transactions, this only magnifies the challenge.
The power of the blockchain
Blockchain technology has powerful characteristics which could go a long way to improving the effectiveness of AML/CTF objectives for both regulators and business, not to mention a marked reduction in the costs of compliance.
With public blockchains, transactions performed on their network are cryptographically verified before every transaction becomes an immutable public record. Transactions are completed in near real time, data is stored decentrally across many nodes which makes it particularly secure and scalable.
However, a major shortcoming in terms of AML/CTF is that they are based on anonymity of users. Private blockchains overcome the issue of anonymity as they are typically used with a predetermined set of users, but they remain insular and only relevant for a specific organization or organizations.
Building AML applications on existing public chains such as Bitcoin and Ethereum will not provide the answer. Even though such apps may be able to identify users and their initial financial transactions, the fact that they are built on top of an underlying anonymous protocol and token means that once a user has conducted an initial transaction there are potential exits to anonymity thereafter. Whilst businesses could monitor those transactions performed by users using their verified credentials, they can not be assured their users have not also performed transactions anonymously. Regulators would not accept such a solution where that possibility exists.
Eliminating the burden of compliance
What is needed is for a blockchain to embed identity into its underlying protocol and token, rather than relying on applications. With an identity insistent protocol, businesses and regulators could leverage the secure, decentralized and immutable nature of blockchain technology assured that all transactions are captured.
Using algorithms, rule engines and smart contracts directly on the blockchain, suspicious transactions could be detected, flagged and identified by regulators in near real time, enabling timely investigation, intervention and action to be taken.
Because all transactions are captured on the blockchain, regulators would have a single global view of transaction flows across borders and jurisdictions like never before. In addition, regulators would be provided with a powerful set of tools to monitor complex transactions, identify suspicious activity and significantly increase their effectiveness in stamping out illicit transactions.
Leveraging the technology in this way would mean the compliance burden and associated costs are greatly reduced for businesses and even more effective, as it is now transferred to the actual blockchain, the source of transactions. Businesses can reinvest that capital into tangible programs for growing their business or increasing productivity.
This is all about creating more effective, cost efficient ways to reduce illicit transactions, addressing the threat of terrorism and freeing up businesses to create greater opportunities for their customers and the broader economy.
As history has shown, where there is substantial waste and a relentless desire for improvement and performance, that is an ideal environment for creative thought to pioneer innovation that later stimulates the widespread adoption of new solutions. With innovation comes inevitable change and we are poised to witness this as the benefits of leveraging blockchain itself to deliver much more effective and efficient outcomes in the control of criminal activity are realized. One thing’s for sure, it promises to be game changing.