| May 10, 2024

Compliance Using Blockchain – Banking

Blockchain technology, known for its decentralization, transparency, immutability, and security, is being increasingly utilized in Know Your Customer (KYC) and Anti-Money Laundering (AML) procedures to enhance efficiency and security. In this article, we explore how traditional KYC and AML processes are often fragmented, repetitive, and costly, with significant time and resources required for customer identification, risk assessment, and data verification. By leveraging blockchain’s unique properties, these processes can be streamlined, reducing reliance on central authorities, lowering costs, and improving data management. Furthermore, the use of zero-knowledge proofs (zkProofs) in blockchain enables data reusability across different platforms, significantly reducing redundancy in KYC procedures. Several companies, such as SEBA and DLT, are already implementing blockchain-based KYC/AML solutions, demonstrating the practical applicability and benefits of this innovative technology.

Existing Implementations of AML and KYC

The traditional Know Your Customer (KYC) procedure is mandated by global and local regulations e.g., the Bank Secrecy Act in the USA and the Money Laundering Regulations in the UK, with the primary aim of preventing financial crimes such as money laundering, fraud, terrorism financing, and identity theft. The KYC process typically kicks off with a new user registering on a platform, where they are required to provide essential information like their full name and address. On the other hand, Anti-Money Laundering (AML) procedures encompass a broader range of measures aimed at preventing financial crimes.

In both the AML and KYC onboarding processes, a Customer Identification Program (CIP) is an initial step where essential customer information such as name, date of birth, address, and identification number is gathered.

Detailed Process:

  • Customer Identification Program (CIP): This step involves collecting essential information such as name, date of birth, and address from the customer to establish their identity.
  • Customer Due Diligence (CDD): This step entails assessing the risk level associated with the customer, which may require collecting additional information to understand the nature and purpose of the customer relationship.
  • Enhanced Due Diligence (EDD): For higher-risk customers, enhanced due diligence is conducted to gather more extensive information and conduct closer monitoring.
  • Account Opening: Once the customer’s identity and risk level have been ascertained, an account is opened for the customer.
  • Annual Review: Customers’ profiles are reviewed annually to ensure the information is up-to-date and to reassess their risk levels.

In the digital era, some of the steps have been refined. For example, customer verification may involve:

  • Selfie Check or Face Authentication: Determining whether the true document holder is present during the onboarding process.
  • Address Verification: Determining whether the customer comes from the claimed region.
  • Beneficial Ownership Check: Identifying and verifying the identity of the beneficial owner, where relevant.

The traditional KYC processes usually involve a centralized system where individual data is stored in a single location. This centralized storage approach makes the data susceptible to breaches and attacks, posing significant security risks.

Much fragmentation, lack of reuse

How long does it take to do this?

The duration of the AML and KYC onboarding processes can be quite lengthy due to the meticulous procedures involved in verifying customers’ identities and assessing their risk levels. The KYC process, for instance, is known to be time-consuming, especially if financial institutions do not employ efficient practices. During onboarding, a customer is contacted on average ten times, indicating the extensive interaction required to complete the process. Moreover, manual processes involved in AML compliance, such as identifying and verifying customers, monitoring transactions, and reporting suspicious activities, are not only time-consuming but also prone to errors.

How much cost is involved?

The costs associated with AML and KYC onboarding processes are substantial. Thomson Reuters research revealed that 92% of firms estimated the cost of KYC onboarding processes to be roughly $28.5 million. Furthermore, a single KYC compliance check can cost between $13 and upwards of $130, making the average cost to banks around $60 million per year. Automation, however, has been noted to reduce costs by minimizing the need for internal resources dedicated to manual identity verification, KYC, or CTF checks.

References: 5 Essential Steps for KYC Onboarding and AML Compliance

Data Fragmentation and Why Repetitions Are Involved?

Data fragmentation is a significant issue in the traditional AML and KYC processes. The common pain points in KYC reviews relate to data collection, transaction analysis, and determination of sources of wealth, which often result from non-standardized data formats, duplicate, and incomplete data.

KYC remediation, which entails organizing information, finding inconsistencies in the data, and determining appropriate next steps, often arises due to data fragmentation and requires additional time and resources to resolve.

Repetitions are prevalent due to the need for continuous updating and verification of customer information, especially during the onboarding process. The repetitive and manual processes surrounding document collection and company structuring can be quite burdensome. Maintaining, monitoring, and updating KYC data is critical for effective AML/CFT processes, and this requirement leads to repeated actions, particularly when there are changes in customer information or risk profiles.

Blockchain as the answer

Traditional Traits of Blockchain:

Blockchain technology is known for its decentralization, transparency, immutability, and security. These traits make it an attractive solution for managing and verifying customer data securely and efficiently. The decentralized nature of blockchain reduces the reliance on central authorities or intermediaries, thus potentially lowering costs and increasing efficiency.

Reusability of Data (zkProofs):

Zero-knowledge proofs allow one party to prove to another that a statement is true, without revealing any information beyond the validity of the statement itself. In the context of KYC, zkProofs enable an individual to verify their identity once with a trusted KYC provider and then prove their identity to other third parties without having to go through the verification process again. This significantly reduces the redundancy in the KYC process, saving time, effort, and resources for both customers and financial institutions. The ability to reuse verified data across different platforms or organizations while maintaining privacy and security is a notable advantage of employing zkProofs in the KYC process.

Examples of Implementation:

  • SEBA: A Swiss blockchain company, that provides a blockchain-based KYC/AML solution enabling secure and efficient customer onboarding. KYC/AML in Web3 and Blockchain Technology
  • DLT in KYC/AML Compliance: DLT (a broader category including blockchain) facilitates the sharing and validation of KYC data among financial institutions, thus reducing duplication of compliance efforts and associated costs. Using blockchain for KYC/AML compliance

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