Blockchain in KYC Verification & Anti Money Laundering (AML)
Knowing with whom they are trading is one of the most important jobs of banks and other financial institutions like insurance companies, stock exchange, etc. Because of this very reason, these financial institutions conduct the KYC or Know your customer process as this process provides them with a sense of security. KYC verification ensures the authenticity of the other party involved.
The KYC process is initiated when a customer intends to work with a financial institution, for example, a bank. Initially, the financial institution and the customer agree on certain terms of a relationship.
Then, the customer sends the required documents like ID proofs, credit card information, utility bills, etc to that institution to conduct the KYC verification process.
After receiving these documents, the institution analyses them and generates certification, where the customer is either validated or rejected to avail of the services. The process is repeated every time a customer initiates a relationship with any financial institution.
For example, if a customer wants to open an account in bank A, he has to exchange his documents with Bank A and has to go through their KYC process. After receiving his documents, Bank A will verify them and after that, he is allowed to open an account in bank A.
But when he intends to work with other banks let’s say bank B and bank C, he has to again exchange his documents and has to again go through KYC verification process with the respective banks B and C. These multiple validations are time-consuming and at the same time leads to an unnecessary increase in the cost of KYC validation.
Blockchain — The solution
So quite naturally, there is a need for a solution that can make the KYC process easier. Blockchain technology can provide the required solution and can act as a single point of truth in this case.
After the implementation of Blockchain, a customer will be required to undergo the KYC process only once. This KYC information and validation will then be stored on the blockchain and later on, he can share this KYC verification result with other financial institutions with which he intends to work.
Application 1: KYC Verification
Let’s discuss in detail how KYC verification will happen on the blockchain. To understand this let's revisit our example:
i). When the customer approaches Bank A for the first time, the bank will conduct the core KYC verification process. The customer will share his documents with the bank, which will then be analyzed by the bank. After the documents are analyzed, they will be stored as digitally signed documents in the smart contract of that customer created by Bank A. Additionally, the smart contract will also include the result of the core KYC verification done by the bank for that customer (can be either accepted or rejected).
ii). This smart contract for the customer will also hold details about other banks or financial institutions that will validate the KYC of that customer in the future.
iii). Additionally, each of the documents of the customer that has been used for KYC verification will be stored in local databases of the banks.
iv). In this blockchain-based system, whenever the customer intends to work with another bank, say Bank B, he needs to only share the address of his original smart contract, where his KYC verification documents and verification result by Bank A has been stored.
v). The verification result by bank B will also be stored in the customer’s smart contract. Thus, the customer’s smart contract will contain complete information about the financial institutions with whom he has worked.
So you can see that blockchain technology enables the same customer to work with different banks while the exchange of documents and the core KYC verification process needs to be done only once.
Application 2: Preventing Money Laundering
Curbing money laundering is a big challenge for banks. The criminals earn large amounts of money from illegal activities, such as drug trafficking, terrorist activity, tax evasion, bribes, kidnapping, etc.
Now in order to avoid detection from legal authorities, these criminals perform money laundering to create an illusion that the money they obtained from illegal activities originated from a legitimate source.
A Bank or a financial institution is used at some point of these money laundering procedures for converting the Black money into White. One of the ways that they perform money laundering is by first dividing the accumulated sum of illegal money into smaller chunks and then depositing these smaller chunks into the accounts of unconnected depositors.
Therefore, it is obligatory for any government or financial institution to create a regulatory framework that makes it difficult for individuals to convert money obtained from illegal activities into legitimate assets.
The mainstream financial ecosystem has been developed in such a way that there are numerous checks and balances that can prevent money laundering. And Know Your Customer or KYC verification process is one of the most important checks implemented by these institutions in this direction.
But the biggest challenge with the KYC verification process is its increased regulatory cost that is borne by these financial institutions.
- In fact, it is estimated that the yearly cost that financial institutions spend on KYC verification is around 60 million USD.
- Moreover, these costs are augmented by the fines levied on financial institutions due to their misconduct with regard to anti-money-laundering (AML) and KYC regulations.
- These costs are approximated to be about 10 billion USD.
- Additionally, KYC verification is a time-consuming and painful experience for the customers too.
Thankfully blockchain technology has the potential to solve this issue related to KYC verification.
If all financial institutions adopt blockchain, KYC data of the customers can be shared across financial institutions in a secure, transparent, and seamless manner. The benefits of blockchain technology for financial institutions are huge.
- Specifically, the technology enables the creation of a chronological, decentralized interbank ledger using which financial institutions can verify the result of the KYC verification process that has already been conducted for a customer, thus avoiding the need for conducting redundant KYC verifications
- Moreover, the cost of the KYC process can be minimized and can be shared proportionally among the financial institutions that work with a specific customer
- This technology will be very helpful for the regulatory bodies since the distributed ledger provides a transparent record of the KYC process that financial institutions had undergone prior to working with their customers
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