Blockchain and Covid-19: A new era for financial crime compliance?

Data diversification in a pandemic

Institutions of all shapes and sizes have faced significant challenges in their bid to manage the broadening scope of regulatory requirements amid the escalating Covid-19 pandemic. Increasingly complex structures between financial institutions and platforms such as payment providers and gaming companies have increased the breadth of shareable/common structured and unstructured data. This makes it harder to process data, validate transactions, and keep up with regulations in order to avoid compliance issues; not to mention privacy concerns impacting GDPR legislation.

More complex still is the continued battle to stay on top of document management and decision making over detailed customer due diligence (CDD) processes.
In other words, it is fundamental for compliance departments to collect necessary information whilst avoiding gathering disproportionate or irrelevant details, and a continued challenge to navigate the delicate balance between regulatory requirements and customer satisfaction.

An opportunity for blockchain?

The main question being asked by my colleagues in government and law enforcement agencies is:

“How can fraudulent individuals and groups be deterred from criminal activity in an already rapidly evolving threat and regulatory landscape?”

Well. Technology is clearly considered one of the foundational pillars to a solution approach in most socio-economic contexts. Many financial institutions, grappling to comply with current and upcoming regulations, are exploring systems to increase efficiency with managing significant amounts of bulk data. The ambition is to mitigate risks arising from poor data analysis, as well as to avoid undetected malicious activities (both insider and otherwise). A particular type of technology identified to support (even replace) manual processes is distributed ledger technology (DLT), commonly referred to within the context of blockchain.

Blockchain as a DLT-based system could be used as a distributed database and verification system for financial transactions via a publicly viewed ledger. Institutions would record and keep track of transactions, and each party in a transaction would be assigned a cryptographic key that would require validation by the participants in the network. Once credentials were verified by the network, the transaction would be completed, and an encrypted block would be created. What makes blockchain so interesting then is the principle of distributing immutable and transparent ledger copies, which independently verifies consensus processes that are used to validate any changes.

But what are the concrete implications in terms of money laundering? The key lies with the integrity of data. A customer’s background, financial records, source of income, wealth and assets can only be placed on a blockchain once there is consensus across the whole network that all that information is accurate. Under these requirements, it would be extremely difficult for any false information to be submitted and for internal fraud to take place. Given that each data entry is cryptographically hashed, it would be virtually impossible to tamper with the information once it is verified and put on the blockchain.

An additional consideration would also be that client information could be stored separately in various institutions’ databases. The institutions may include banks, transport, tax/revenue departments and judicial authorities. With the distributed ledger, all background information and identification could be stored on one blockchain network for institutions to access during the CDD process. This could make the Know Your Customer (KYC) process faster, more comprehensive and significantly more secure against instances of human error or internal fraud.

Consensus and collaboration is the first step

Clearly, all of this is merely the tip of the iceberg when discussing blockchain potential – the practicalities of such a transition would require a revolutionary step up in legislation and regulatory technology. But, if the Covid-19 pandemic has taught us one thing, it is that we are capable of working in union to defend a common enemy and operationalising practical solution strategies.

It would require a coordinated and harmonised effort between regulators, financial institutions, auditors, and other stakeholders to achieve – but could see blockchain play a fundamental role in improving regulatory reporting, identity management, due diligence, and transparency; not to mention making it infinitely harder for criminal activity to evolve and/or remain in the shadows.