Predictions about financial services can be very tricky things.
The credit card was not conceived by a bank CEO or a Federal Reserve Chairman, but by science fiction writer Edward Bellamy. In his 1888 utopian novel, Looking Backward, Bellamy predicted a future where individuals spend credit from a central bank through the use of a card.
Not bad for a college dropout. Of course, mobilepay would have been even harder for readers to accept in the 19th century. And blockchain technology…
Limitless examples of failed predictions from prominent people, even experts, exist. One especially relevant to this article is the spectacularly wrong and public prediction concerning the internet from U.S. astronomer Dr. Clifford Stoll in Newsweek in 1995:
“They speak of electronic town meetings and virtual communities. Commerce and business will shift from offices and malls to networks and modems. And the freedom of digital networks will make government more democratic. Baloney. Do our computer pundits lack all common sense? The truth is no online database will replace your daily newspaper, no CD-ROM can take the place of a competent teacher, and no computer network will change the way government works.”
What are you reading these words on, by the way?
Changing perspective via blockchains
Stoll’s predictions prove more incorrect every day. The introduction of blockchain technology picks up where the internet leaves off, in providing additional digital freedom through the democratization of recordkeeping services.
This newfound freedom is becoming a hot topic for the entities that currently oversee recordkeeping activities, such as governments and banks. Facilitation of financial crimes, such as money laundering and terrorist financing, present a key challenge. [See also Joseph Mari’s “When blockchain, cryptocurrencies, and AML meet”]
However, consider that the concept of blockchain technology and its first use case, cryptocurrency (i.e. Bitcoin), has existed for less than a decade. And that the combined total market cap of all cryptocurrencies is less than $15 billion (USD, mostly Bitcoin), in comparison to the $800 billion to $2 trillion (USD) laundered every year, according to estimates by the U.N. Office of Drugs and Crime.
It would be premature to make binding predictions regarding how this technology will be used with respect to financial crimes in the future—especially if they will hinder its present-day growth.
Enhancements on the horizon
Some have argued that money laundering is facilitated by banks, rather than blockchains. This statement is potentially misleading in that it could imply complicity. With few exceptions, traditional financial institutions do not knowingly participate in financial crime. And there are robust regulations and stiff penalties for those who do.
Banks represent the existing order when it comes to finance. So it is inevitable that some individuals will attempt to use their services for money laundering. And some observers ask if current keepers of the financial services ecosystem are inherently criminalistic or otherwise flawed, due to their indirect-even if unwitting involvement with money laundering. I would argue that neither is true.
However, the legacy systems which underpin traditional banking institutions may be in need of significant enhancements. Technology is advancing at a rapid pace and the previously unthinkable is becoming stark reality. The recent SWIFT breaches, as well as the first of its kind hack of approximately 20,000 Tesco Bank customer accounts represent new alarm bells.
Blockchain technology presents equal parts challenge and opportunity for traditional financial institutions.
• Challenge, by way of increased competition and potential for operating outside existing regulations.
• Opportunity, through the opening of new markets and streamlining of internal functions, such as bookkeeping and audit controls.
One major advantage that is made possible through blockchain technology is the potential for “triple entry” bookkeeping.
This builds on the current double-entry system. It does so by adding an additional entry into a blockchain that cryptographically seals and timestamps the details of a particular transaction. (This includes data on entities involved, value exchanged, etc.)
Potential advantages to a triple-entry system can range from decreased costs associated with internal audits to near-perfect financial statements being published. Furthermore, regulators such as FinCEN, could build off this new method to allow for the accessing of real-time analytics from reporting entities for the purpose of fighting financial crime.
Triple-entry bookkeeping is just one example of why it is wise to keep an open mind towards the positive potential of blockchain technology.
Another example would be the first blockchain, the Bitcoin blockchain. From a concept in an obscure whitepaper penned in 2008 by an anonymous author, Bitcoin has grown to a current market cap of approximately $12 billion dollars (USD).
But more importantly, its underlying technology has the global financial services industry focusing on what it does and more.
It is impossible to discuss the potential of blockchain technology without referencing Bitcoin. But it’s almost become a ritual. Everyone wants to hear about the wonders of blockchain without hearing the word “Bitcoin.”
I would argue that this is impossible—or counterproductive at the very least. Explaining what blockchains are without referencing Bitcoin is akin to trying to describe the English language without referencing the alphabet.
Bitcoin is the world’s first blockchain, indeed, the world’s biggest blockchain. Many of the private blockchains being developed through prominent consortiums have Bitcoin core developers as consultants, including R3CEV and Hyperledger. Bitcoin’s influence is far-reaching and needs to be considered when discussing blockchain technology.
However, being both the spark of the blockchain revolution and one of the main reasons for its slow adoption, Bitcoin and, by association, other blockchains, have been put into a unique situation. A situation that presents a new paradigm in the discussion of money and banking, as well as their regulation.
Policing the future
Let’s say a time were to come where blockchain technology was ubiquitously accepted as the new normal for the technological foundation of financial services. Then it would not be a stretch to imagine cryptocurrencies, issued by a central authority or not, becoming commonplace as well. [See also, “Like blockchain? Will you love ‘Fedcoin’?”]
At this moment we see governments around the world exploring the possibilities of digital currencies, such as in Canada, Singapore, and Sweden.
Conversely, the actions undertaken by other countries have indirectly caused many of their citizens to flock to decentralized cryptocurrencies such as Bitcoin. This was recently witnessed after the Indian government passed a law banning the 500 and 1,000 Rupee notes in November 2016. The intent was to require exchange of the notes to catch tax cheats and other users of “black money.”
The aforementioned initiatives have been implemented for many reasons. Reducing state expenditure and combating financial crime are two of the more prominent motivations. One by way of counteracting the Bitcoin effect, the other through restricting access to larger denominations of fiat currencies.
Ironically, both approaches have further entrenched Bitcoin within the global narrative when it comes to money.
Subtle change in the regulatory role
This unexpected outcome can actually have a significantly positive effect on the creation of new regulations for the financial services industry. Such benefits that leverage off the possibilities created through the introduction of a shared recordkeeping ledger, or network of interoperable ledgers.
Blockchain technology democratizes finance and associated services. This notion will require an evolution in existing regulatory legislation. In an anti-money-laundering sense, such an evolution may see an expansion of the definition of a reporting entity to account for the increased autonomy in transacting.
Governmental Financial Intelligence Unit’s (FIU) may also want to consider moving towards partnering with additional entities (automotive dealers, luxury goods retailers, etc.) who could possibly accept cryptocurrencies in the future. This could give FIUs a seat right at the table, so that large transaction reports would be sent automatically to them when a certain threshold is broken in cryptocurrency value.
So, potentially, cryptocurrency—still suffering a taint in some circles—could come to be leveraged in the fight against financial crime, such as money laundering.
Calling a truce
The U.N. Office on Drugs and Crime estimates that between 2% and 5% of the world’s GDP—$800 billion to $2 trillion (USD)—is laundered globally per year. The total market cap of all cryptocurrencies combined—approximately $15 billion (USD), as mentioned earlier—is about 2% of the lesser figure. Given that the large majority of transactions on these blockchains are not attributed to money laundering, one begins to realize that the present-day threat posed appears to be minimal.
This realization should empower governments and traditional financial institutions to engage in reasonable dialogue on the development of blockchain technology for the purpose of its potential inclusion within the existing financial services ecosystem.
Conversely, the U.N.’s global money laundering figures should also depict the immense responsibility that existing financial institutions have to bear to those players in the emerging blockchain space.
However, before there can a truce, both sides must acknowledge that neither side is inherently bad.
When that happens, both can turn their focus towards those who actually perpetrate financial crime.