Apr 12, 2019
Global system, global issues and local compliance, how do we reconcile blockchain with AML and KYC?
Decentralised platforms running a blockchain know no geographical barriers and in the purest form such as Bitcoin anyone can trade with anyone.
The effects of corruption is debilitating for societies and countries, and there have been efforts to stem corruption by stemming the proceeds of crime. The anti-money laundering (AML) regulations require organisations to ensure they know the origin of funds to prevent the proceeds of crime being “cleaned”. AML is a global problem and criminals do not respect geographical boundries.
There is a requirement in finance to perform a “Know your client” (KYC) test, and this is a check to verify that the person or institution are who they say they are and additionally to check the suitability of a prospective client to enter into a transaction. The first check relies on government databases such as official residency checks or for the applicant to supply evidence of their address from two separate sources (utility bills, bank statements etc). The second one may require further disclosure such as their holdings and checks to ensure the prospective customer’s appetite for risk.
The KYC checks full under the regulator of the country of residency in the case of an individual or where a company is officially registered and are thus local to each country.
How do we reconcile a borderless application with checks at a supranational and national level?
One solution used in the crypto space is to use whitelists and exclude people from certain countries or to include only a subset of prospective investors such as “accredited investors”. There are issues with how long tokens are held, who the holders are allowed to sell to and how many holders are permitted.
In theory a fixed number of tokens are made available to citizens of one country who may only trade them with citizens of that country who meet the KYC requirements, there may be another block of tokens issued to citizens of another country with similar terms. Now our borderless platform is beginning to look a little fragmented, and complying with the regulations in each and every country begins to look very expensive.
If we consider the purpose behind the regulations, they are in place to ensure that investors are protected and that their suitability is considered before they invest. Since the history of mankind there have been dishonest schemes that promise many things to make an investment look very attractive, and at the worst just run off with the money given to them, or the fabulous scenarios promised never materialise.
When considering AML and the origin of funds, is there inherent bias in global AML checks? Politically exposed people associated with one regime may be seen as the entrepreneurial class, to others there may be too many questions around the influence they have and whether their wealth is truely derived from their endevours?
How can a borderless platform be built with the considerations of AML and KYC?
Let’s consider a supply of tokens that is made available on a platform, the next question is who is allowed to buy them?
Clearly there needs to be an assessment what these tokens represent; what is their inherent value? what are the tokenonics that underpin them? what level of financial disclosure is there?
Given that the needs and concerns of the regulators in each country are similar, perhaps the best solution is to find a way to standardise the information so that each one can make a simple and informed decision? A global classfication system could be developed for each instrument so, again, the local regulator could map that to local rules?
The issue of a unified AML list is more problematic, and one solution is a consensual list being created of known criminals and the more difficult one around PEPs. This would work by a mimimum number of participants agreeing to the data by proposing and voting to the creation of the lists. Note the creation of a list would not be appropriate on the blockchain as people have the right for convictions to be forgotten after a period of time and an imutable store would not be the best place for this. A solution would be something along the lines of an off-chain store with the hashes stored on chain as discussed in the article “Mutable datasets and blockchain”.
The KYC regulations by definition remain local and as discussed above a standardised approach to classifying tokens would help regulators map it to their local rules. Indeed a tool that would inform regulators of a new token with all the data attached, the regulator could then attach a local classification to the token and then when prospective investors look at a new token the information is available.
This would build a basic model for tokens but there are local regulations that stipulate how these can be promoted and distributed, in more relaxed regimes social media adverts may be acceptable, others require lengthy disclosures that there is inherent risk in investing, and in some countries investment in crypto is banned entirely.
Regulations developed in each country to differing needs and have evolved to reflect the protection of their citizens and institutions, and where there have been holes in the past there are patches to ensure that the same events are not repeated. Working to help the regulators classify tokens would be a big step forward, the existing rules are in place, so that if a token looks like a security then it is one and thus needs to be treated as one. The KYC rules then remain a local issue, the challenge then is how a token is sold and promoted.
