Globalization and the rapid advancement in technology have created a powerful new headache for banks and governments everywhere. Money laundering is estimated to equal a staggering $2 trillion per year. To put this figure in perspective, that‘s roughly the equivalent to the entire GDP of Brazil, the world‘s 8th largest economy.
In the past, money laundering involved couriers carrying large amounts of currency to corrupt offshore banks or organizations that would thenÂ launder it. These days, money laundering has become incredibly sophisticated thanks to the new ways that technology allows for money to be transferred throughout the globe.
As I pointed out in a recent article, “5 Examples of Blockchain Uses in Financial Services”, the finance industry stands to benefit enormously from blockchain implementation. One of the main ways it stands to benefit is from the increased security that comes with this exciting new technology.
In this article, I intend to examine the ways companies in the future will be able to use blockchain solutions to prevent money laundering. Anti-money laundering or AML is already big business. For those companies that can create effective new blockchain-based technologies that can help prevent money laundering, the financial rewards will be enormous.
I will begin by examining what money laundering is and give examples of how it has beenÂ fought in the past. I will also look at some of the most common ways that money laundering is performed to show just how sophisticated some of these schemes can be.
After this, I will take a look at some of the ways in which blockchain can be implemented in order to prevent such illegal transactions from taking place.
What is Money Laundering?
When we talk about laundering or ’washing‘ money, we are not talking about throwing it in a washing machine to get the bad smell and stains out.
Money laundering is the process whereby money obtained through illegal activities is processed to make it appear that it has come from a legal source. There are lots of ways that this can be done.
Perhaps the simplest way is to record these illegal gains as being sales made by a legitimate business. Provided that the income is within a reasonable level of expectation, such activities are very hard to spot without conducting a thorough audit.
It is for this reason that this form of money laundering detection is so difficult.
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Other Methods To Launder Money:
- Cash smuggling – Taking money offshore to tax havens etc.
- Shell companies and trusts – Allows criminals to hide cash anonymously.
- Trade-based laundering – Inflated prices are used to funnel in cash to legitimate businesses.
- Round-tripping – Money is offshored and legally returned as an investment.
- Corrupt Accounting via a Controlled Bank – Criminals take over a bank then use it to wash money.
Money Laundry Prevention
The task of trying to prevent money laundering inevitably falls on every government around the world. Most governments have already enacted laws that make such practices a financial crime.
The most recent country to pass money lending legislation was India. In 2002, its parliament passed the Prevention of Money Laundering Act. This law not only made money laundering a crime, but also authorized the seizure of any property believed to have been bought with laundered money.
Since the law was enacted, India‘s federal agency has investigated a huge number of cases, the most famous of which involved the Punjab National Bank (PNB). Officials allege that the PNB laundered some $1.77billion for a “few select account holders”. What is perhaps most shocking, and is also a good indicator of how widespread money laundering really can be, is that PNB is actually a state-run company.
Laws which authorize the seizure of property and set out harsh punishments for those who get caught laundering money are the first step towards preventing money laundering.
One of the big landmarks in money laundering prevention came after the 911 attacks in the U.S. The U.S government’s focus on cutting terrorist funding helped them target and shut own many of the world‘s worst culprits.
Using the Financial Action Task Force on Money Laundering, the U.S and its allies were able to increase surveillance on suspected governments, companies, and individuals in order to establish who they were washing money for and how much money was involved.
Their efforts not only led to them freezing financial assets of countries such as Iran and North Korea, but also to some unexpected places too. In 2012, leading British bank HSBC was fined $1.9 billion for engaging in money laundering.
Governments now have more tools than ever before to find and prosecute money launders. Their ability to access and monitor huge amounts of financial records of suspected individuals is perhaps their most powerful tool.
Other things such as increased border security, biometric data on passports, increased integration between different government institutions such as the police and tax departments etc., as well as big data analytics that help to pinpoint suspicious transactions, have boosted the battle against the money launderers.
For more information on countries and their money laundering laws, please click this link.
Bitcoin and Money Laundering
Bankers and government spokespeople are very fond of labeling Bitcoin a tool for drug dealers and money launderers.
While there is little doubt that Bitcoin and other cryptocurrencies are used for illegal purposes that include money laundering, the majority of users are small-time investors or people who wish to support this new technology.
There are a number of illegal acts that a decentralized currency like Bitcoin can facilitate. The most widespread crime is tax evasion.Â A recent report estimated that some 36% of Bitcoin investors plan on committing tax fraud this year.
This is because Bitcoin is believed to be completely anonymous, something which is slowly starting to be understood as not completely true. TheÂ many ordinary investors who flocked to cash in on last year‘s surge in price, but never declared their profits to the tax department, may well find themselves with hefty back taxes to pay in years to come.
Bitcoin has also been used to transact payment from ransomware attacks and other kinds of cyber fraud.
Arguably the second most common illegal use of Bitcoin is for money laundering. This is because individuals and companies can transfer large sums of money without any regulatory oversight.
However, such transactions do carry a high level of risk. Since the blockchain ledger is unalterable, these will remain on the chain until the end of time.
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Should the Bitcoin network ever be cracked by authorizes, and the unique key numbers linked to their owners, then no high priced lawyer in the world is going to be able to convince a jury their client is innocent given the immutability of the blockchain data.
How to use blockchain technology to prevent money laundering
There are severalÂ use casesÂ for blockchain technology when it comes to AML compliance.
Immutable Ledger For Regulatory Oversight
The fact that blockchain technology uses a decentralized network, where each participant or node is required to validate changes, makes it incredibly secure.
Provided a hacker is not able to gain control over 51% of the nodes on the network, something which would require a supercomputer that does not yet exist, any unauthorized change would be automatically resisted by the other nodes.
Since each node has a record of the entire ledger, they are able to compare any change to their record and therefore detect any unauthorized change.
This particular aspect of blockchain technology means that blockchain ledgers can be completely trusted. Regulators would, therefore, be able to example records knowing that the information contained within them was reliable and accurate.
Establish Trustworthy Identifications
Having an immutable ledger that records verified ID‘s of those behind each and every electronic transaction can act as a massive deterrent to money laundering. Once again, since such a ledger would be unalterable, it would provide definitive proof in a court of law of a person or company‘s involvement.
Any blockchain-based database that involved money or property could be programmed to record a verified identification of each party for each transaction. This would mean that these individuals could then be held accountable in the case of any wrongdoing.
Right at this moment, companies like Evernym, a startup that has developed its own blockchain, Sovrin, are racing to develop more secure ways of verifying people‘s identification.
Currently, the market relies on companies such as Equifax, who rely on client-server systems to maintain their databases. In this article, Vinny Lingham, CEO of Civic points out the problem of such systems; “These centralized databases are central points of failure for your identity.”
This gives the development of blockchain KYC solutions a huge advantage over the systems currently in use.
Blockchain for AML transaction monitoring
The question of how to detect money laundering using blockchain technologies is a complex one.
Essentially, any deployment of a Blockchain-based AML solution would require the use/integration of smart contracts. A blockchain-based AML platform that utilizes smart contracts would be able to use inbuilt algorithms to automate the process of AML fraud detection.
By programming in a series of requirements, such as the need for verified ID, this technologyÂ would be able to automatically block or red flag any suspicious transactions. In this way, it would be possible to gain oversight over all digital transactions made through participating financial institutions without having to hire huge teams of auditors to check the transactions.
Governments would be able to enact laws making such oversight law, meaning that all financial institutions and cryptocurrencies would have to facilitate such a system in order to operate.
Such a solution would work by allowing each participating financial institution to act as a node on the blockchain. Whenever a transaction was made, it would be scrutinized by the network and could be flagged in the case that it was suspicious and needed investigation.
It can be argued that an integrated blockchain solution, where all the nodes are established financial institutions, is not in the spirit of the true decentralization concept outlined by Satoshi Nakamoto. Â However, the prevention of money fraud, which last year cost governments 10‘s of billions of dollars in lost taxes surely has to be more important.
My Final Thought
All of this is exciting stuff.Â While the development of a ubiquitous blockchain solution that helps prevent widespread money laundry is still very far off, this new technology does have enormous potential to succeed where in the past we have failed.
Don’t forget that it was only after last year‘s cryptocurrency price spike that a vast amount of the new startups that are currently working on this problem were created. Examining some of the ICOs held over the last 12 months gives a good picture of just how much interest and innovation there is in this field.
Small-scale startups are tending to focus on solving smaller pieces of the puzzle. The work of companies like Evernym, for example, is already helping to solve the problem of ID verification, which is a major part of money prevention of money laundering.
When it comes toÂ making a larger dent in the estimated $2 trillion that gets laundered every year, it is going to take the combined effort of governments and the entire finance industry as a whole to really solve this problem.
Given that some of these institutions have been found guilty of money laundering too, getting them to enthusiastically participate in developing a workable solution might be harder than actually developing the solution itself.
What is clear is that blockchain offers a chance to help put an end, or at least massively reduce, a criminal activity that has been around for millennia.
Let‘s hope that blockchain can succeed whereÂ all others have failed.