In 2005, having a digital presence meant having an email address and maybe a Myspace account, which in 2006 surpassed Google to be the most visited website in the United States.
Fast-forward to 2020, Myspace is a distant memory while seemingly the entire world has a Facebook account, and Google is worth close to $1 trillion USD. The digital world as we know it has been flipped upside down over the last 15 years, and while social networks come and go, the digital revolution has just begun in a much more important sector: Finance
By the year 2023, 80% of the world’s population will have a digital presence online, equating to roughly 6.4 Billion people. As financial institutions race to onboard the estimated 40% of the world’s population which still remains unbanked, a massive challenge already burdens them. Fraud prevention and Know Your Customer (KYC) protocols have become a multi-billion dollar expenditure for financial institutions. Banks lost approximately $31 billion in 2018 due to fraud, while anti-money laundering (AML) spending reached over $8 billion. At the same time, banks are under regulatory pressure from governments to better protect client data, as seen by Europe’s recent adoption of the General Data Protection Regulation (GDPR).
In their effort to combat fraud, financial institutions have set up well funded fraud prevention teams to protect data and prevent money laundering. While these initiatives have introduced real time information sharing and built predictive models, it has also has lead to higher costs and longer onboarding times, which results in increased friction and lowered customer experience. As banks shift to digital services, they now have more access to customer and transaction data than ever before, yet are struggling to prevent fraud & reduce costs while increasing customer experience. So what can banks do to streamline these processes?
The Answer: Blockchain
Bank ledgers are traditionally built on a centralized database, which is susceptible to hacking and cyber attacks as all of the information is stored in one place. Blockchain technology stores data in a decentralized manner, with copies of the information stored in multiple locations (nodes), with each location having equal access to read and verify to the data. Try to illegitimately change the data, and the network of nodes will detect & override the breach. This type of network is dramatically more secure against data manipulation such as hacks or cyber-attacks. While blockchain technology has many applications within the banking and finance sectors, let’s take a deeper look into how blockchain can reduce fraud (and thereby costs) for financial institutions.
A Blockchain Based KYC
A blockchain based identification system will enable customers to create a digital fingerprint which will act as a unique identifier (similar to an actual fingerprint unique to each human), and has numerous advantages. Once this blockchain based digital fingerprint is created, the owner can use it to open a new account or prove their identity to any bank on the network. This eliminates the need for banks to conduct redundant KYC and AML checks.
Additionally, as a copy of your KYC compliant documents are stored on a blockchain, the information would be secure, transparent, and decentralized. The decentralized nature is key, as when a bank or financial institution needs to verify a customers identity, they would simply need to be given permission from the client to access the data. Think of it as personally owning your bank verification data, and whitelisting which financial institutions may access it. As the blockchain stores identical copies of your data, this means that everyone with access will view the same exact information, leading to increased efficiency and increased customer experience for clients. Clients will be able to update their personal accounts across all platforms at once by signing with their digital signatures, and every institution would seamlessly be updated. In practicality, this means clients won’t have to contact each financial institution they do business with (banks, credit cards, loans, etc) to update them, and each institution won’t have to conduct their own redundant & costly KYC/AML checks.
“When used in combination with other technologies, a blockchain KYC utility demonstrates strong potential to help financial institutions reduce the time and cost associated with KYC processes, while providing greater visibility to regulators and better customer experience.” -KPMG
Speaking of costly, let’s take a peek at just how expensive KYC/AML is, and how much those costs can be reduced. According to a Thomson Reuters survey, the average cost for financial institutions to meet their obligations is $60 million, while some are spending up to $500 million on KYC procedures. Implementing network interoperability & automation has the capability to drastically reduce costs, as recently shown by tests conducted by KPMG.
KPMG Singapore & Bluzelle Networks developed a blockchain based KYC proof of concept (POC) with a Singaporean regulator and three Singaporean banks which passed all of the Monetary Authority’s tests. The test platform resulted in an estimated cost savings of 25-50% by reducing duplication and providing a transparent audit trail. Building on those tests, according to a McKinsey report, this type of blockchain based system can reduce bank fraud by $7-$9 billion, reduce operating costs by $1 billion, and reduce regulatory fines $2 - $3 billion.
Money laundering has a different cost on financial institutions, one not measured in fiscal losses due to fraud, but rather through the loss of reputation & status in the eyes of the public and regulators. Regulatory fines then further compound the pain. According to a PWC survey, money laundering is five times more likely to occur with a financial institution, with 50% of respondents highlighting that money laundering is their biggest risk in doing business globally, and 29% felt that money laundering has a “severe impact” on their businesses reputation. A blockchain based KYC/AML will be able to automatically run compliance & background checks against existing AM & anti-terrorism lists, reducing the amount of human labor that financial institutions must invest.
With a blockchain kosher stamp of approval, it’s clear that financial institutions will be able to reduce costs, improve customer experience, and enhance their reputations. However, there is a long way to go towards adoption as questions linger about the technology and its implementation. New privacy laws need to be taken into account when building a digital identity system on an immutable network. Heavy up-front capital costs hinder banks from building new shared network systems and obsoleting their legacy independent systems. Customers must agree to perform additional authentication steps during onboarding. Liability issues remain such as if Bank A completes the KYC onboarding, is Bank B responsible if fraud occurs on their account?
Regardless of the growing pains of this revolutionary technology, the future of digital identity and finance are being developed on blockchain technology as we speak. Financial institutions have begun internal tests, startups are racing to create secure blockchain based ID’s, and even JP Morgan Chase has created its blockchain network and US dollar stablecoin to improve payments, clearing, and settlement times (more to come on this in a later post). Regardless of which blockchain platform it’s built on, the fact remains clear, this is the way.