The Road Ahead in Anti-Money-Laundering (AML): Can Blockchain Technology Turn the Tide?

One of the most exciting developments in financial and information technology in the past decade is the emergence of so-called blockchain technology. A blockchain is a database of information distributed over a network of computers rather than located on a single or multiple servers. The first and most famous practical application of blockchain technology is the electronic currency Bitcoin. Bitcoin and similar cryptocurrencies using blockchain technologies offer users the equivalent of anonymous cash transactions, and have been linked to illicit transactions in drugs, weapons, and prostitution as they. It is therefore no wonder then that blockchain technology is sometimes viewed as a problem, or at least a challenge, for those interested in fighting financial crime and corruption.

But blockchain technologies have other uses, many of which could in fact aid in the fight against these crimes. In an earlier post on this blog, Jeanne Jeong discussed how blockchain technology could be used managing land records. Another use for blockchain that has occasionally been mentioned (see here and here), but not yet sufficiently pursued, is anti-money-laundering (AML). Currently, banks spend about US$10 billion per year on AML measures, yet money laundering continues to take place on a vast scale. The goal of laundering money is to “wash” illegally obtained money (e.g. through corruption) into “clean” money, making the origins of the money untraceable. Blockchain technologies have five features that could make AML efforts both more effective and less costly:

  • Consensus: Due to blockchain’s distributed ledger technology, everyone (or at least everyone involved) is able to see the same information on a transaction instantly. Rather than having databases that communicate with each other and update individually, blockchain updates happen simultaneously. In other words, banks can be sure that “I see what you see,” “I know that you know that I know,” and so on. This is essential for trust and has the potential to cut out the middlemen in transactions.
  • Validity: Blockchain technology provides certainty that every update in the system is valid, because the technology ensures that there is a common agreement on the rules of transactions. This makes it harder to game the system, for example by claiming database errors.
  • Uniqueness: It is impossible to create two conflicting entries into a blockchain system, making it impossible to pretend to source the money legally while actually sourcing it illegally.
  • Immutability: Because blockchain records are distributed over the whole network in a distributed ledger system, rather than a central database, blockchain transactions that were recorded are practically “immutable.” The data of past transactions cannot be changed, but only updated, and the data on previous transactions remains permanently available. Thus, once the data of a transaction have been recorded (including the previous owner of money, the new owner, and the basis for the transaction), these data are not falsifiable.
  • Authentication: Every transaction is associated with at least two private keys, while the concept of a “master key” is not part of a blockchain. This is very different from current database systems where an administrator or “super-user” could alter the database single-handedly, which is clearly risky from a security perspective.

In sum, transferring money with blockchain technology makes it possible to trace the historic and current ownership of every penny in the system. It is like being able to look at the serial number on every dollar bill and identify every person who has ever held that dollar, as well as when, where and why it changed hands.

Theoretically.

As of today, blockchain is still a black box for most regulators, banks, and businesses – and even for many technological providers. Ever since Bitcoin was introduced in 2008, commentators have discussed how this technology will revolutionize the financial industry (e.g. here or here), yet few applications have found their way into the main financial institutions. Probably the most pressing challenge to move forward with blockchain technology in the financial industry – as noted by regulators and banks alike – is the standardization of the blockchain protocol. Currently, there are multiple cryptocurrencies, blockchain networks, and protocols available, with hundreds of financial technology players fragmenting the market. Without standardization, most benefits of blockchain will be unachievable, as the different networks will not be able to communicate with each other simultaneously. Also, without a sound understanding of the technology, it will be hard for users – both in the public and the professional sphere – to find trust in the technology. And trust is the most crucial element for financial transactions.

But things are changing rapidly. On October 24, for example, Commonwealth Bank and Wells Fargo announced the successful completion of the first cross-border trade between banks using multiple blockchain technologies. And on November 30, 2016 Corda, the blockchain technology ledger developed by a consortium of more than 70 of the world’s biggest financial institutions will be open sourced – meaning that the underlying code will be made available publicly at no cost. It will be exciting and crucial to see how Corda will be integrated by the different financial players. Contrary to most other open source standards, Corda has some distinct features:

  • It enables individual banks to build own products on top of the standard;
  • It focuses on individual agreements between firms, rather than full transparency by not copying all data to all participants of the blockchain (this should allow for privacy protection);
  • It integrates “legal prose” in agreement to allow for disputes to be resolved transparently and quickly;
  • It allows business logic to be written into the existing code.

Should the industry be able to adopt that standard on a wide scale, it would give regulators, auditors, and judges the opportunity to focus their efforts on building the necessary processes into the blockchain system of individual banks and of the overall industry for monitoring and oversight of lawful transactions. Indeed, the widespread application would provide the legislative and executive branches new and powerful enforcement mechanisms to fight money laundering by being able to see the entirety of any transaction instantly and accurately– a big step forward in the global fight against corruption.

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