How to Prevent Money Laundering Using Blockchain

prevent money laundering with blockchain

Interested in knowing how to use blockchain to prevent money laundering? 

Look no further as this is what we will discuss here.

Besides all the money to be made by creating new bloackchain solutions, innovating in this industry is a chance to improve the society we live in. Here are a few amazing case studies of companies that hired DevTeam.Space to build their software products:

  1. DDKOIN – Leading Cryptocurrency
  2. Dencenture – Blockchain Mobile App and Web Application
  3. Medicoin – Healthcare Blockchain-Based Web Application

Introduction

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 then 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 prevent money laundering with blockchain. 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.

However, building such challenging projects will require hiring highly-skilled and reliable blockchain developers.

I will begin by examining what money laundering is and give examples of how it has been 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 financial transactions from taking place.

Contents

What is Money Laundering?
Money Laundry Prevention
Bitcoin and Money Laundering
How to Prevent Money Laundering with blockchain?
My Final Thought

What is Money Laundering?

A money laundering scheme

The task of trying to prevent money laundering inevitably falls on every government and law enforcement
agencies 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. It requires banks to record all transactions over Rs. 1 million and generate currency transaction reports (CTRS).

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 $1.77 billion 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 financing helped them target and shut down many of the world‘s worst culprits.

Using the Financial Action Task Force on Money Laundering, the U.S and its allies were not only able to cut down financing of terrorism but also 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 in foreign banks 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 investigate suspicious activities 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 measures such as increased border security, biometric data on passports for efficient customer identification, increased integration between different government institutions such as the police and tax departments, etc., and big data analytics that help to pinpoint suspicious transactions, have boosted the battle against the money launderers.

Under criminal sanctions, the US has criminalized money laundering. The US congress has passed a series of laws in this regard, collectively known as Bank Secrecy Act (BSA).

The US is one of the few countries who requires its financial institutions to report cash transactions greater than certain thresholds or if deemed suspicious for their source, etc. 

These Suspicious Activity Reports (SAR) are stored in a financial database called FinCEN. These reports are accessible by US criminal investigators for investigation purposes.

Countries like Canada and Australia also require money service businesses, real estate agents, dealers in precious metals, to report their financial activities under Proceeds of Crime, Terrorist Financing, and Money Laundering rules and acts. 

Globally, countries determined to combat money laundering are also working in partnerships. One such example is of FATF, formed by G7 countries to fight against the financing of terrorism.

Similarly, United Nations Office on drugs and crimes maintains an information system and software for aniti-money laundering data analysis, etc.

For more information on countries and their money-laundering laws, please visit this resource.

Bitcoin and Money Laundering

Electronic money transfers, especially wire transfers with anonymous numbered bank accounts, should be an easy way to launder money. But, technological capabilities help to prevent such fraud. 

Therefore, bankers and government spokespeople are very fond of labeling Bitcoin as a tool for drug dealers and money launderers.

While there is little doubt that Bitcoin and other cryptocurrencies are used for illegal purposes that includes 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. 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. The many ordinary investors who flocked to cash in on Bitcoin’s repeated surges 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 jurisdiction.

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.

Should the Bitcoin network ever be cracked by authorities, 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.

The good news for governments is that the same blockchain technology that allows these currencies to exist can also be used to help with prevent anti-money laundering laws in the future.

How to prevent money laundering with blockchain

There are several use cases for blockchain technology when it comes to AML compliance and the fight against money laundering.

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 examine 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’s 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 customer identification.

Currently, the market relies on companies such as Equifax, which rely on client-server systems to maintain their databases.

In this interesting 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 Customer Due Diligence (CDD) or know your customer (KYC) solutions a huge advantage over the systems currently in use.

Blockchain for AML Compliance Programs

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 program that utilizes smart contracts would be able to use inbuilt algorithms to automate the process of AML regulations for fraud detection. By programming in a series of requirements, such as the need for verified ID, this technology 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 implement a financial system making such oversight money laundering regulations, meaning that all financial institutions and cryptocurrencies would have to facilitate such a system in order to operate.

Such money laundering schemes would work by allowing each participating financial institution or treasury 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.  

However, the prevention of money fraud through money laundering activities, which cost governments 10‘s of billions of dollars in lost taxes surely has to be more important.

 

My Final Thought on Prevent Money Laundering Using Blockchain

All of this is exciting stuff. While the development of a ubiquitous blockchain solution that helps AML compliance officers to prevent widespread money laundering programs 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 ICOs 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 to 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 where all others have failed.

Frequently Asked Questions

1. Can blockchain prevent fraud?

Blockchain solutions will help to turn the tide in many areas when it comes to the battle against fraud. One area that will really benefit is international money transfers which will be automated using blockchain, something which will be developed in such a way as to cut down fraud.

2. Is blockchain suited to stop money laundering?

Smart contracts will set specific criteria that the sender and receiver must fulfill before it is successful, while a permanent record of all transactions will be stored on the blockchain, helping to cut down on fraud.

3.  Are there any blockchain solutions for money-laundering prevention? 

There are numerous solutions currently under development. However, no AML solution is in widespread use.

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