Combating Money Laundering and Terrorist Financing with a Distributed Ledger

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Despite the staggering $8 billion figure estimated to be spent on global compliance in 2017, U.S.-based rules regarding Anti-Money Laundering (“AML”) and Combating the Financing of Terrorism (“CFT”) remain anchored in their 1970s design. Contrary to the generally slow pace of Congressional action, new technologies may reshape the global financial system (“GFS”) and with it, the ability to detect and disrupt money laundering schemes and terrorist plots. Chief among these is blockchain, a peer-to-peer technology first implemented as the backbone of the virtual currency Bitcoin.

For those new to blockchain, the basic theory is simple: whereas today’s GFS depends on banks and intermediaries to record each and every financial transaction that passes through it, blockchain utilizes a distributed database in which new and existing entries must be approved across an interconnected network of “locally” held, mirrored ledgers. To add a transaction to the database, its details must first be broadcast and authenticated according to previously-agreed upon procedures.

Importantly, whereas Bitcoin has become regarded in part as a technology subject to the potential abuse of protecting the identities of potential criminal actors, the underlying blockchain technology itself has the potential to vastly improve transparency in the GFS. This is made possible by the fact that the database is open-source and rigid: new entries are approved only upon satisfaction of a verification “up-vote” by those who maintain local ledgers. Given that all ledgers must look the same, it actually becomes much harder to manipulate transactional data.

Practically speaking, shifting the GFS from a centralized and siloed system to a decentralized and distributed system may alter fundamentally the way we transact. A subtler question is how, if at all, this shift could affect AML/CFT efforts. In a word: tremendously.

With a distributed ledger, banks and regulators alike could have unfettered and real-time access to far more detailed transactional and cross-institutional data than is currently available. In the United States, most AML rules of course flow directly from the Bank Secrecy Act (“BSA”), a 1970 law that requires, in part, financial institutions to monitor their customers, report suspicious transactions, and maintain customer records to be audited by the government. Under the current system, enforcement of the BSA and other AML/CFT rules depends primarily upon the inspection of transactional data housed separately by individual financial institutions. Although Section 314(b) of the Patriot Act provides these institutions with a circumscribed ability to share information to better identify potential AML/CFT violations, banks and other intermediaries ultimately are responsible for inspecting their own ledgers for suspicious activity. For anti-graft proponents and national security experts alike, blockchain presents something of a breakthrough in data analytics: by viewing all transactional data across the full-spectrum of the GFS, the ability to detect money laundering schemes and terrorist financing plots may improve radically.

It is no small irony that the foundation of Bitcoin, a trustless and anti-fiat currency, over time may serve to strengthen dramatically both the GFS and its effort in identifying and holding accountable those who manipulate it. To be sure, the GFS is complex and bad actors can take extraordinary steps to attempt to disguise unscrupulous transactions. Given the need to enable banks, intermediaries and the government to speedily verify the credentials of parties, real-time monitoring of a decentralized and distributed ledger has the promise to disrupt some of the most common money laundering and terrorist financing techniques, and may very well serve to revolutionize the GFS.

But as with all potential revolutions, we must be wary of its unintended consequences. Policymakers and industry alike first must determine how to best protect personal and corporate data, which institutions will partake in the ledger’s verification and editing process and how government access should occur. Although implementing blockchain stands as one of the best potential opportunities to better compliance with AML/CFT rules, and as traditional financial institutions increasingly embrace the technology and its use becomes more ubiquitous, these questions, and a host of others, must be answered.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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