Application of Blockchain Technology for KYC
The inception of blockchain technology manifested through Bitcoin, a peer-to-peer digital cash scheme where digital currency is transferred on a purely peer-to-peer basis, without the need of intermediary. Blockchain is a unique mix of several breakthroughs, including cryptography, distributed ledger technology and smart contracts. These technologies enable the creation of a decentralized database that is immutable, secure and transparent. The properties of blockchain technology have sparked the minds of industry insiders to create enterprise solutions for improving their in-house efficiency, security and auditability.
Know-Your-Customer process and their deficiencies
The Know-Your-Customer (KYC) processes require banks to conduct in-depth due diligence, document validation and verification for their new retail and corporate clients. This ensures compliance with the stringent and constantly changing Anti-Money-Laundering (AML) and KYC regulations. The current problems associated with KYC processes are:
- Time consuming – the KYC process for onboarding customers can take 30 to 50 days to be completed to a satisfactory level[i];
- Costly – KYC due diligence can take up to US$15,000 to 50,000 per client.[ii] The average cost of complying to Customer Due Diligence (DDC) and KYC requirements, as reported by 800 financial firms, constitute on average US$ 60 million yearly, and in some cases up to US$ 500 million;[iii]
- The introduction of increasing costs – an Accenture study reports that over last three years AML compliance related costs have increased to 50% for banks;[iv]
- Burdensome for Customers – 89% of customers claim that they have faced a poor KYC experience in their financial institutions;
- Highly flawed – whilst banks and financial institutions spend excessive funds on their KYC and AML compliance systems, banks accrued about US$8 billion in regulatory fines due to flaws and mistakes in their CDD and KYC procedures. Notable examples include: US$1.8 billion fine imposed on HSBC for failing to prevent US$ 880 million being landed by Mexican and Colombian caters; and IGN bank’s US$619 fine because of failure to comply with US sanctions against certain countries;
- Ineffective – Yearly money laundering transactions comprise US$ 2-5 trillion or 5% of the global GDP.
Thus, financial institutions started exploring and investing in technologies that could help them to reducing some of the costs associated with AML and KYC compliance, where they finally turned to blockchain as a potential technology to relieve some of the burden.
Applicability of Blockchain for KYC processes
The current procedure of KYC services can be primarily divided into three groups: customer onboarding; monitoring; and reporting. The customer onboarding process includes large manual involvement, where institutions must verify and validate their customers identities, conduct background checks against the sanction lists of entities and individuals, and store the data in their servers. After successful onboarding, financial institutions must then deploy the appropriate software to conduct real time transaction monitoring and data analytics to identify suspicious transactions. The subspecies transactions identified by software programs are consequently manually reviewed by employees. Finally, Banks need to continuously collect information on their customers and report to authorities the list of customers who might be involved in any activities that violate AML regulations. Each financial institution keeps the record of their customers and generally refrain from sharing due diligence results with other institutions. This multiplies the cumulative efforts spent on one customer.
Advantages of Blockchain Technology
Blockchain technology can be utilized for purposes of improving KYC and AML compliance, increase efficiency and cut costs.
Blockchain based shared databases of Customers can help to avoid duplicative efforts of KYCs and CDD checks for onboarding Customers. The ledger could also enable encrypted updates to clients’ details to be distributed to all banks in near real-time. Thus, it would help to eliminate the repetition of mundane documentary tasks through collaboration and privacy-preserving sharing, while shifting the focus of human intervention to the higher-value tasks of risk evaluation and decision making. It will additionally enable a shared economy environment (where the whole is greater than the sum of the parts); an inclusive ecosystem that is open to all banks, corporate customers, third party service providers, and regulators.
Further, Blockchain can help to create a complete historical record of all documents shared and compliance activities undertaken for each client. The immutable nature of this technology will increase transparency and trust through technology. Up-to-date shared standards helps to improve the collective knowledge of AML risk and double-blind privacy model ensuring client confidentiality.
Additionally, Blockchain can be used to create a reputation system encoded into the database that distinguishes between customers according to their rating. There are already proofs of concepts in use for this purpose. For example, The Shyft Network aims to provide a new paradigm for digital identity — one focused on leveraging reputation as collateral and setting a new standard in the attestation process. Shyft is a reputation network that enables base layer identity anonymization and KYC data-anchoring. Shyft assigns individuals and businesses with Creditability scores, defining their reputation, plausibility, believability and the likelihood that they are creditable.
[ii] Goldman Sacks report “Blockchain: Putting the theory into Practice” 2016.