Blockchain technology has the potential to transform finance, but its applications are still being discovered. Although criminals are now using cryptocurrencies technology to launder money, the blockchain technology behind them may eventually be used to link crypto accounts to specific individuals.
Growing regulations on cryptocurrencies have also encouraged the rise of alternative, AML-compliant cryptocurrencies, which is a balanced approach to advancing the adoption of digital currencies without the risk of fraud.
In the coming years, we will certainly know more in terms of blockchain’s potential to impact real-time global transactions and merchant fraud protection. Blockchain technology will continue to mature, and with it will come increased and stronger regulatory measures. The big question remains around the short-term and long-term impacts of this newly adopted technology, as we continue to address solutions in the fight against financial crime online.
Blockchain technology has been touted as a revolution in finance, and across many other industries. Despite its great potential and upward momentum, blockchain technology has quickly developed a reputation of facilitating money laundering and other types of fraud.
This anonymous, decentralized form of currency naturally attracts thieves, who develop methods to either steal from the exchanges or use the blockchain for elaborate fraud schemes. As the technology advances, governments and regulatory agencies are searching for ways to detect and prevent cybercrime without impeding the many benefits of blockchain.
What makes blockchain technology useful and valuable is its built-in security model. Blocks are verified by a cryptographic function called a hash, which is randomly generated from the block's input data (many times, a huge amount of content). Generating a hash essentially standardizes any sized input into a simplified, unique identifier, similar to a signature or fingerprint. It is also important to note that in order to generate a new hash, one must have the hash of the previous block.
The key benefit of this system is that it makes the blockchain immutable. Since blocks can't be altered once they've entered the chain, the blockchain can be distributed to multiple parties without alteration. Even if the parties are untrusted or unknown, they can still agree that the blockchain remains intact.
As the transaction ledger for Bitcoin, blockchain technology was conceptualized in 2008. Every Bitcoin transaction made is stored in the blockchain and distributed to those running the free, community-driven bitcoin software. Users create virtual wallets, each of which contains multiple cryptographically generated addresses, or computer generated IDs. When a user sends money to another user, their addresses and the transaction amount are verified and generated as part of a new block. Once the block is added to the chain, each user's wallet balance is updated to reflect the flow of Bitcoins to or from their address.
Unlike credit cards and bank accounts, which are tied to an overseeing individual or organization, cryptocurrencies track transactions using these anonymous addresses. Without knowing the personal information of the address, it's difficult to determine who was involved in a transaction.
However, since addresses are recorded in the blockchain, it is possible to trace each transaction where the address was used. This led to the desire for additional privacy and the development of completely anonymous cryptocurrencies such as Monero. Monero creates a new address for each transaction, “obscuring sender, recipient and transaction amount." Multiple transactions of the same amount are bundled together, mixed and sent to different recipients, functioning as a built-in laundering system making it extremely difficult to identify the sender.
While blockchain-based cryptocurrencies are supposed to be anonymous, making them seemingly ideal for all types of online fraud, there are still ways to identify users.
For example, online exchanges allow users to buy and sell cryptocurrencies using debit cards, bank transfers, and wire transfers. When users register with an exchange, they are given virtual wallets with their own addresses. Each transaction on the exchange flows through these wallets, creating a permanent record of each user's actions. Yet public and private keys, signatures, and transaction validation still leave many holes in the process with multiple points of illegal access.
To comply with local laws, many exchanges require customers to submit some form of ID, such as a photocopy of a driver's license or passport. Bitcoin's surge in late 2017 led to a 10x increase in demand for compliance companies that help businesses verify customer identities.
Despite some blockchain applications being used illegally, the technology may eventually make it easier for lawmakers to trace transactions. Because blockchains are permanent, tamper-resistant ledgers with publicly available copies, they may be able to be used for monitoring and analysis by regulatory bodies. For example, researchers from the University of Padua in Italy were able to estimate how much bitcoin has been paid to cybercriminals as ransomware, by creating a database of bitcoin accounts associated with the cyberattacks. Future compliance officers may be able to use a similar method to create a list of suspicious accounts to monitor for money laundering and other forms of fraud.
Five years ago, the Financial Crimes Enforcement Network labeled cryptocurrency exchanges as money-services businesses, subjecting them to Bank Secrecy Act laws and regulations. The EU has proposed subjecting cryptocurrency exchanges and wallet providers to AML regulations, should risks not be addressed and could impose these rules before the end of 2018.
Globally, electronic money laundering, also known as transaction laundering, is approaching an estimated $500 billion this year. In February, Europol estimated that $4 billion to $5 billion was being laundered through cryptocurrencies. In response to money laundering and illegal markets, governments are beginning to recognize cryptocurrencies as financial assets and cryptocurrency exchanges as financial markets.
The need for accountable cryptocurrencies sparked the creation of AML BitCoin. AML BitCoin was designed with built-in compliance to the BSA, the USA Patriot Act and other international regulations. The NAC Foundation, the creators of AML BitCoin, see it as a way to promote the acceptance of digital currencies while fighting and preventing money laundering and other forms of fraud.