While globalization and technological advancements have improved business operations, digital financial crimes under money laundering have also taken advantage of new technologies. The estimated amount ofglobal money launderingis around $2 trillion per year. This figure is almost equal to the entireGDP of Italy, the world’s 8th largest economy. Many banks spend approximately $900 million to $1.3 billion annually to improve and manage their KYC0 and AML processes.
In addition to the high costs of KYC/AML compliance, financial institutions are constantly under client pressure to facilitate transactions efficiently. In many cases, compliance programs are slow, fragmented and manual, which slows down the client’s business and ultimately damages the client’s relationship.
The article discusses how Blockchain helps overcome money laundering issues and simplify the KYC process and what are the benefits of implementing blockchain in AML/KYC.
- What is money laundering?
- Can Blockchain prevent money laundering?
- Why is KYC a detachable part of AML?
- How does Blockchain work for AML compliance?
- What are the use cases of Blockchain in AML?
What is Money Laundering?
Money laundering is the illegal way of making large amounts of money through criminal activity, for example, terrorist funding or drug trafficking. There are numerous ways to accomplish money laundering. The simplest way is to record these illegal earnings as sales by a legitimate business, provided that the amount is within a reasonable level of expectation. Other methods for money laundering are:
- Bulk cash smuggling
- Black salaries
- Gambling on cricket
- Trade-based laundering
- Round tripping
Can Blockchain prevent money laundering?
Blockchain technology possesses inherent characteristics that can potentially prevent money laundering. Every transaction done over blockchain leaves behind a permanent trail of records which is impossible to be altered. Thus, it makes easier for authorities to track the original source of the money.
A public blockchain ledger can supervise, validate, and record each transaction’s complete history. The public ledger’s readers and crypto miners get immediate notification of transactions as they occur. If all the transaction phases, including destination wallet, departure wallet, currency type and amount, are anyhow left unverified, the transaction gets immediately blocked. Blockchain also enables money laundering risk analysis and reporting mechanisms. It allows overall system analysis rather than monitoring just entry and exit points.
- Immutable ledger for regulatory oversight
The Blockchain is a decentralized network where each user or node has to validate changes. This feature makes the network incredibly secure. Every node has a record of the entire ledger and can compare any modifications and detect any unauthorized changes. Since Blockchain removes unauthorized changes, it brings integrity and immutability to the data. - Establishes trust
Since the ledger is verifiable and immutable, it automatically incorporates the trust of the users. Blockchain most simply and securely establishes trust for any transaction helping in the movement of money or any other sensitive data worldwide. - Transactions monitoring
Integration of Smart Contracts in a Blockchain-based AML platform automates the process of fraud detection in the system. In-built algorithms keep a continuous check on every transaction, automatically generate an alert for a suspicious transaction and immediately block the transaction. Thus, implementing blockchain in AML enables to gain oversight over all the transactions.
Why is KYC a significant part of AML?
KYC (Know Your Customer) is a critical function to assess customers’ risks and comply with AML laws. KYC comprises customer’s identity, the threat they pose and their financial activities. Any business or financial organization involves the following steps for KYC:
- Establish customer identity
- Analyze customer’s activities
- Evaluate money laundering risks associated with every customer
Building a blockchain-enabled AML/KYC platform can streamline AML/KYC processes by recording data and information related to KYC and AML on a decentralized ledger. The data recorded on a blockchain ledger cannot be altered or removed but is always transparent to all members of the network. Therefore, managing AML/KYC data on the blockchain can help financial organizations maintain data seamlessly.
How can Blockchain-based AML/KYC Platform work?
The following steps explain how AML compliance and KYC processes work using Blockchain.
Step 1: User creates a profile
First, the user would need to complete a one-time registration to create their digital profile on the Blockchain-based AML compliance platform. The system will ask for the user’s details, including proof of the user’s identity and KYC data.
Step 2: KYC verification
Once the information is uploaded, the financial institute (FI) verifies the accessible KYC data. Regular automated checks can be done using various APIs like Trulioo. The user’s data is encrypted and stored on the FI’s server, not on the ledger. It is because KYC data is deemed to be saved off-chain.
After the bank verifies KYC data’s integrity, the information is uploaded on the server and a hash associated with that data is recorded on the DLT platform. If the KYC data is modified in any way, the hash associated with it will immediately change. The other FIs on the network will get an alert of data modification.
Step 3: AML analyst conducts searches against the lists
AML analyst calls APIs to perform Anit-Money Laundering checks. Regular checks are performed to analyze the customers’ financial behavior, including frequency of transactions conducted, amount of money being credited and debited, the provenance of money, paid or pending taxes, etc.
Step 4: KYC monitoring
Based on the AML analyst’s analysis, a risk score is generated, determining the risk level that every individual poses. KYC monitoring can be conducted automatically based on the risk score with a customized scheduling option. For example, if a user’s score is very low (0-10%), their monitoring can be scheduled every three years. For a user with a high-risk score (85-100%), KYC monitoring must be done every week.
If any financial institute or bank needs to access the customer’s data, they request the user to provide access to the KYC/AML document. The user grants permission to access their profile. The bank then reviews and compares the data with the associated hash functions on the ledger. If both of these matches, the bank confirms that it has received the same unmodified KYC data that another financial institute earlier validated.
If the user obtains a new license, passport, or any other KYC document, it needs to be uploaded and validated by the system. Here, a potential inefficiency for the participating banks or financial institutions might occur. Does each FI now need to validate the updated records individually? The answer is no. This situation can be avoided using Smart Contracts that automatically update their system when they provide new documents. The financial institution that holds the user’s updated records verifies and attests its authenticity. The FI then broadcasts this change to all other participating FIs in a new hash function.
What are the use cases of Blockchain in AML?
- Opening a bank account Every bank needs to verify the individual’s identity and conduct KYC due diligence to open a bank account to determine terrorism or money-laundering risks. Working with Blockchain provides various benefits such as eliminating data silos, risk classification, and time-stamped records. While opening a business account, the AML/KYC platform checks for the business’s authorized owners are humans or entities. Personal identification documents are required to accomplish this verification.
- Loan application As per regulations, KYC is crucial when applying for a loan. Checks are conducted to ensure credit-worthiness, money laundering, and financial crime risk calculations. The Blockchain ledger allows the institution’s various service departments to quickly access the customer’s records and complete the loan application process.
- KYC remediation The financial institutions need not ask existing customers again to share their documents for a KYC remediation process. All the required documents, data, actions, and analysis will be stored on the ledger. Automated KYC remediation process extracts license expiration dates and auto-sends reminders to the concerned customer to upload newly updated documents.
Conclusion
Blockchain intends to minimize regulatory risks of which heavy fines are a manifestation because of insufficient or delayed KYC due diligence. Blockchain platform assists risk classification algorithms, Smart Contracts and analysis, and fraud detection. It ultimately supports FIs in administrative KYC processes required for business and individual accounts, cross-border payments, and large financial transactions. The automated DLT based KYC platform significantly reduces AML departmental expenses that tend to increase every year.
Do you want to develop a safe and secure Blockchain-based AML/KYC platform for your business?Get a free consultationand discuss your ideas with our team of blockchain experts.
