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The birth of the digital era created the need for increased business and cyber regulation. Companies are having to rapidly increase compliance budgets and staffing because of regulatory changes involving Anti-Money Laundering (AML) and Know Your Customer (KYC) rules. Legislators and financial organizations have struggled to keep up with cybercrime and blockchain technology provides a solution.

Blockchain Compliance

Security features on the blockchain protect against fraud, cybercrime, and terrorist funding.  Customer due diligence processes are aimed at helping financial institutions avoid involvement in criminal transactions by improving their knowledge of their consumers’ identities and business dealings. In 2016, the Financial Crimes Enforcement Network (FinCEN) issued final rules under the Bank Secrecy Act (BSA) that outline and enforce customer due diligence requirements for financial institutions including entities like banks, brokers or dealers in securities, mutual funds, futures commission merchants, and introducing brokers in commodities.

As part of a client’s risk profile, it is important to go through KYC and AML processes and tax compliance assessments to ensure that your company prevents enabling illegal activities like terrorist and criminal financing. Regulatory compliance has become increasingly costly, time consuming, and error prone, but the penalties for non-compliance are significant. Blockchain technology, specifically distributed ledger systems, can revolutionize regulatory compliance by providing a basic infrastructure for companies dealing with risk management to easily comply with AML and KYC regulations under the BSA. By building compliance rules into the technology, blockchain can assist the financial institutions in locating and analyzing the customers’ transaction history associated with their digital wallet address, detect the suspicious activity and unusual transaction pattern, and investigate the destination of suspicious transactions.

AML

AML stands for Anti-Money Laundering, which now works in conjunction with CFT, countering the financing of terrorism. AML is the analysis of consumer transactions to help detect and report suspicious activity that could be related to money laundering and terrorist financing. Each firm must have a written AML compliance program that runs in accordance to the rules and regulations under FINRA rule 3310.

KYC

KYC, Know Your Customer, is a verification procedure in which a company learns a client’s identity. KYC processes are part of due diligence and require validation and verification of primary documents which can be very costly and regularly takes 30 to 50 days to complete [4].

With the financial technology, Bitcoin, KYC processes are broken into two parts including phone number and personal ID verification.

  1. Step one is a simple mobile phone verification process in which a customer is sent a text message with a code. The customer then enters that code into a specific page during the verification process which validates that the consumer has access to that mobile phone number.
  2. The second step requires the customer to verify their identity by providing a copy of personal identity (ex. an ID, driver’s license, recent utility bill, birth certificate, or passport). In this case, verification processes can take anywhere from a few hours to a week to complete, hindering speed and consumer accessibility.

With innovations in blockchain technology, we see significant reductions in time, cost, and effort involved in KYC processes. A Deloitte report states that blockchain can be useful in “identifying entities attempting to create fraudulent histories. Subject to the provisions of data protection regulation, the data within it could even be analyzed by the banks to spot irregularities or foul play - directly targeting criminal activity.”

DLT

Blockchain technology deviates from the norm by using a Decentralized Ledger Technology (DLT) instead of relying on traditional centralized authorities, providing enhanced safety and security for users. Satoshi Nakamoto, the creator of Bitcoin, describes the problem with relying on a centralized authority as “the fate of the entire money system depends on the company running the mint, with every transaction having to go through them, just like a bank" [6]. DLT allows for a more robust and reliable solution to the double spending problem seen regularly with centralized ledgers. Other problems that arise with the use of centralized ledgers include untrustworthy/corrupt depositories, discriminatory practices of the centralized controller, and loss of records. Blockchain DLT addresses all of these concerns through a decentralized consensus-reaching mechanism, open-sourcing, and transparency [7]. Distributed ledgers allow for the absence of middle men, making the technology more secure and reliable than traditional centralized techniques. Distributed ledgers ensure that multiple copies of a transaction are available for review at any given time, allowing for quicker verification of compliance.

Regulation

RICO

https://www.justice.gov/usam/criminal-resource-manual-109-rico-charges

Racketeering is the act of dishonest and fraudulent business dealings.  In 1970, The Racketeer Influenced and Corrupt Organization Act (RICO) was passed by Congress with the intent of pursuing the eradication of organized crime in the United States. To be convicted of RICO violation, the government must prove that 1) an enterprise existed, 2) that enterprise affected interstate commerce, 3) that the defendant was associated with or employed by the enterprise, 4) that the defendant engaged in a pattern of racketeering activity, 5) that the defendant conducted or participated in the conduct of the enterprise through that pattern of racketeering activity through the commission of at least two acts of racketeering activity as set forth in the indictment.


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