Blockchain Integration: A Disruptive Force Against Money Laundering

Anti-money laundering has been a rapidly expanding area of the
financial industry for the better part of the last two decades. The World
Bank estimates that the volume of money laundering is as much as $3.5
trillion worldwide annually (nearly 5% of global GDP). Given that less than
1% of money laundering activity is actually detected by the banks and
financial authorities, the realm of regulatory compliance has grown
exponentially in recent years to try to incur better outcomes in this regard.
As such, the increasing demands, expectations, and pieces of distinct and
often-complex legislation that accompanies regulatory compliance have
created a need for large, dedicated departments catered specifically to
handling these tasks. However, advancements made in various forms of
financial technology – specifically blockchain – may offer an alternative and
arguably a more effective solution than that of even artificial intelligence and
machine-learning options that have begun to emerge in recent years. These
developments have led many of the world’s most renowned and powerful
financial institutions – as well as those hampered by bloated and
overburdened regulatory compliance departments – to explore the growing
capabilities with respect to keeping their respective enterprises secure and
up to par with all of the latest regulatory requirements.
Simply put, blockchain is a technology that acts as a digital ledger of
transactions that is duplicated and distributed across a chain of computer
networks. It is a method of recording information that is particularly
difficult to hack or alter in a fraudulent way. Popular cryptocurrency options
such as Bitcoin and Ethereum use blockchain technology as the basis for
their markets.4 Where does this factor into the realm of regulatory
compliance one might ask? Well, the integration of blockchain technology
into AML efforts could mean trimming the fat off of a significant amount of
work for compliance departments. Since the plight against money
laundering and other serious financial crimes gained significant traction
with the passing of Title III of the USA PATRIOT Act following the 9/11
terrorist attacks, financial institutions have desperately sought ways to
lower rising costs associated with hiring large compliance teams, bringing
on consultants, and paying for long hours of laborious work in order to keep
up with ever-changing financial regulations. This is for good reason,
considering that it is estimated that AML compliance spending totals
upwards of $30 billion collectively for American financial firms on an annual
basis. Compliance personnel operating under financial institutions whose
internal operations are not up to par with growing technological standards
can spend significant portions of their workdays manually verifying basic customer information and inputting Know-Your-Customer (KYC) information
by hand, essentially wasting a company’s time and funds via this outdated
and grossly inefficient process. The screening and comprehensive risk
mitigation process as a whole is largely overdrawn, though certain aspects
can be of significantly high-pressure, creating an environment that can lend
itself to error. Unfortunately for American and international financial
entities, even the slightest of slip-ups in this regard can lead to costly
monetary penalties and other notable repercussions that can impact the
bottom-line of banks small and large. Inclusive of regulatory penalties, total
AML compliance costs borne by banks amount to ~$18bn annually.2 This is
just one of the areas where blockchain can make a significant difference.
One of the world’s top financial staples, Goldman Sachs, was among
the first to explore the power of blockchain with respect to finance. In 2016,
the company predicted that this technology could spread well beyond solely
cryptocurrency and into mainstream finance. In a special report discussing
blockchain innovation, the firm noted the potential for this technology to
readily address a whole host of business problems – one of these being
overstaffing in the banking sector. The Goldman Sachs report revealed that
using blockchain technology for KYC procedures alone would result in a
significant reduction in the headcount of necessary personnel. This alone
makes delving into this still relatively novel tech a lucrative opportunity for
financial executives of even the smallest of firms. Blockchain can also
enable the onboarding of more customers in the same timeframe as manual
processes with far less resources and funds committed to these efforts,
allowing business to re-allocate their funds to more pressing needs. This
technology can not only streamline compliance requirements by automating
many of the aforementioned manual processes tied to regulatory checks and
balances, it can be especially useful in providing automatic risk ratings or
cross-referencing information that can be verified by using smart contracts.
Smart contracts are programs stored directly on the blockchain that runs
when pre-determined conditions come to fruition. Each time these
conditions inserted into the blockchain code by a bank or company are met,
an action or series of actions are executed automatically, triggering the next
step in the workflow process. These steps do not require any type of manual
input aside from the initial coding, allowing them to proceed in real-time –
creating operational efficiency while cutting out unnecessary manpower
needs.3 This means that much of the mindless data input and “chain of
command” protocols that require human beings would effectively become
obsolete. Additionally, these technologies can cut false-positive rates for theverification of payments or when pertinent information is misrepresented or
incomplete during the transaction monitoring process. Altogether,
blockchain integration can significantly impact AML monitoring procedures
for the better by making financial transaction information more mutual via
the creation of distributed ledger which could drive meaningful industry
cost savings in transaction surveillance and the KYC/onboarding process.2
There are also many perceived benefits of using blockchain to boost
the customer experience. Given that many financial institutions have
differing standards and requirements of information needed to verify the
true identities of their customers, it can be particularly tedious for clients of
multiple banks to have to supply a growing list of varying personal
identification and financial information to each respective institution.
Blockchain could alleviate this annoyance by having all of that information
stored on a distributed ledger that can be accessed by any authorized
company that needs to verify a certain customer or relationship. On the
flipside, in many cases KYC verification is a duplicative process – with banks
generally required to independently vet prospective clientele even when the
account has already been vetted by other firms. Should this information be
more easily accessed and transferred from one firm to the next, it can lead
to even more savings for financial firms while eliminating headaches for
virtually all parties involved.
While it appears that financial executives and customers would be
happier utilizing blockchain, the same cannot be said for many compliances
analysts and even officers. The reality is that further automating manual
regulatory-related workflows with blockchain and other forms of potent
financial technology would inevitably result in additional lost jobs in an
the industry already struggling to keep talent. While the analysts that do keep
their jobs may enjoy a mass reduction in monotonous data input
requirements, many will probably not be so lucky. As these technologies
become more sophisticated and require less human intervention, the bubble
of the BSA/AML compliance job market is likely to burst at some point in
the near future.
Citations
1. Devanesen, Joe. “Taking the Fight to Financial Crime with Blockchain-Powered
AML/KYC.” TechHQ, 30 June 2021. 
2. Schneider, James, et al. “Blockchain: Putting Theory into Practice.” Goldman Sachs |
Profiles in Innovation: , 24 May 2016. 
3. “What Are Smart Contracts on Blockchain.” IBM. 4. “What Is Blockchain?” Blockchain Explained: What Is Blockchain? | Euromoney