Regulators have handed out fines totaling $26 Billion to global financial institutions for failing to comply with AML and KYC requirements. Ouch.
Technology plays an increasingly important role. Automated sanction screenings, facial recognition and state of the art fraud detection are just a few recent innovations to help us with day-to-day KYC and AML.
Looking at the big picture, blockchain technology represents the biggest leap since the internet. But what exactly is it and what impact will it have on the world of compliance?
What Is Blockchain Technology?
The first thing to understand is that a blockchain typically operates as a decentralized, time-stamped record of transactions.
You can think of it as a distributed ledger. If you look at the notepad on your desk, imagine that same notepad lying on the desk of every member of your network. Whenever a transaction is performed, everybody’s ledger is updated in real time, 365 days a year, with no down time and without the need for a bank or service provider.
Every transaction is checked, validated and added to the blockchain by network members incentivized to ensure its integrity. The network topology is such that members entering and exiting the network can be easily dealt with, making the whole system impressively robust.
Of course, the word you hear all the time in association with blockchain technology is cryptography. Cryptography plays a vital role in the peer to peer transactions processed on the blockchain. Cryptocurrency addresses typically comprise two cryptographic keys: public and private.
The private key, the one required to access and send funds is under the complete control of the individual. This makes the token holder the ultimate beneficial owner with similar capabilities to a fully fledged bank.
Crucially, blockchain technology is open source and publicly visible, meaning the codebase can be audited and many transactions can be viewed.
Enjoy unprecedented transparency
With this in mind blockchain technology has the capacity to be transparent and easily auditable. Risk teams and regulators could easily study the recorded data including transactions, lending activity and more to get an impressively clear and comprehensive picture about where the money is coming from.
Blockchain analytics platform Chainalysis takes this a step further, providing incredibly detailed information on wallet addresses. This data can then be used to meet AML and KYC compliance obligations by monitoring the cryptocurrency related activities of your customers. The level of detail surpasses that provided by global financial institutions.
For governance professionals, the ability to enjoy real-time transparency on customer-activity is a game-changer. Compliance solutions can be set up to receive this kind of data and use it to generate risk-scores for customers.
Identify customers faster (KYC)
Know Your Customer (KYC) procedures are arduous for users and resource-intensive for businesses. According to Forbes, spiraling KYC requirements were responsible for a 16% increase in the cost of onboarding new customers in 2018 — an unacceptable amount.
Blockchain technology has the power to fundamentally change how businesses verify their customers identity. SelfKey is leading the charge by building a blockchain-based identity management system that will allow users to own and manage KYC information.
Leveraging Ethereum’s smart contract-enabled blockchain, members of the SelfKey network will be able to pass all relevant personal data to a third party service with the click of a button. Using state of the art cryptography, the transfer is not only much faster than a normal KYC procedure, but it is also much safer.
In this case, blockchain technology is a win-win, saving the customer time and the business valuable resources. All KYC information can be collected from the customer in an easy, machine-readable way.
In addition to the advantages mentioned above it solves another crucial issue: data collected by most financial institutions today is held in silo’d databases. They are incredibly limited in how they can communicate with the outside world and represent the last refuge of a soon-to-be-gone era.
Instead, distributed ledger technology has the power to combine all data onto one cryptographically secure platform. With the help of sophisticated data governance models, institutions could use this large array of inter-institutional data to identify fraud more quickly and fight financial crime more effectively.
Sensitive data and blockchain technology
Over 4 Billion (with a B) sensitive records have been exposed in 2019 alone. News of data breaches, hacks and leaks comes to light every day and it seems clear that our current approach to data management is broken.
Blockchain technology offers an innovative approach which puts the individual back in control of their personal data, and relieves some of the data management burden from businesses. More specifically, I’m speaking of zero-knowledge proofs (ZKPs), which allow users to provide vital information without sharing any data.
If ZKPs fulfil their enormous potential they could massively reduce the amount of sensitive data that is shared between individuals and corporations. Who knows, 100 years from now, it may be possible for businesses to operate in a fully compliant manner without actually storing or accepting any personally identifiable information. Watch this space.
Conclusion- The impact of blockchain technology on compliance
I believe that the impact of blockchain on compliance will be twofold. First innovators like Chainalysis and SelfKey will improve on the current system by introducing a decentralized, trustless identity layer. This is the first step to enhancing the privacy of the customer while minimising the burden on the business.
As we have seen, a distributed public ledger has the power to significantly enhance transparency with regulators and subsequently improve the reporting process. The unalterable record of transactions is perfectly suited for audits and should be greeted with open arms by regulators.
In the long-term, ZKPs and other blockchain-based innovations will turn identity management on its head, fundamentally changing compliance requirements as we know them today.