Financial crime has evolved to be more sophisticated, and malicious actors continuously exploit vulnerabilities to commit fraud and theft.
Nasdaq and Verafin’s 2024 Global Financial Crime Report said that around $3.1 trillion of illicit money flowed through the global financial system last year. The funds went into crimes such as terrorist financing, human trafficking, and drug trafficking.
The same report also revealed that $485.6 billion were lost to scams and schemes. Around $6.7 billion was lost to business email compromise, while $3.8 billion was lost to romance scams and similar schemes. No less than $77.7 billion in fraud was stolen from elderly victims.
Blockchain technology has the potential to improve fraud prevention measures. According to blockchain analysis firm Chainalysis, only 0.15 percent of cryptocurrency transactions are used for illicit purposes.
How can blockchain prevent fraud?
Blockchain is an immutable digital ledger. When used accordingly, it can heighten the security of various transactions with its decentralised framework.
Each transaction on a blockchain is accessible to all participants within the network. This results in real-time auditability and verification, which can prevent data manipulation and fraud.
Since the recorded data is distributed across many computers, it becomes more resistant to manipulation. Any transaction data recorded there cannot be altered or deleted. The process creates a permanent audit trail, which makes it difficult for fraudsters to cover their tracks.
There are several blockchain-powered mechanisms that can help prevent fraud in transactions. One example is identity verification using cryptographic techniques. All recorded identity information is digitally encrypted and stored in the network. Like consensus mechanisms, digital identity verification works through multi-factor authentication, making it difficult for criminals to misuse identity data.
Another example is smart contracts. These are computer programmes that execute agreements automatically between two parties. It can automate financial transaction processes, minimising human intervention and exploitable errors.
Case studies
Several financial institutions have successfully implemented the blockchain technology to combat fraud. Last year, Nasdaq executed the first-ever share trade using blockchain with its proprietary Linq platform. Nasdaq enabled the startup Chain to sell shares to an unnamed technology investor.
Linq provides a historical record of securities issuance and transfers, enhancing governance, transfer of ownership, and auditability. With blockchain, Linq reduces risks associated with delayed settlements and administrative burdens.
Barclays Bank, on the other hand, has been exploring blockchain’s potential applications over the past years. To enhance the safety of transactions, the bank uses blockchain in its payments infrastructure and smart contracts in its post-trade processes. Additionally, Barclays is an investor in ‘Utility Settlement Coin’ (USC), a blockchain project aiming to reduce risks in trading processes.
JP Morgan also leverages blockchain technology to mitigate fraud in its transfer system. The company uses Confirm, a global account information validation application on the blockchain, to allow partner banking institutions to request confirmation of beneficiary account information. Partners receive near-real-time responses from other participating banks.
Aside from reducing processing and verification time, the method heightens the safety of transactions. Payments can be sent through J.P. Morgan’s global clearing solution only after they are validated by Confirm.
Challenges and opportunities ahead
Despite the promising potential, blockchain technology faces several challenges in its fraud prevention application.
Blockchain is still relatively new and has not been widely adopted across the financial industry. Therefore, it lacks clear regulatory frameworks to operate, which results in uncertainty that hinders its adoption. Furthermore, current blockchain platforms often face scalability issues that limit their ability to handle large volumes of transactions.
Before blockchain is available for large-scale applications, financial institutions and developers must address these concerns.
Still, the future of blockchain in reducing financial fraud appears to be promising. In 2022, KPMG’s Banking Industry Survey revealed that 92 percent of senior executives said their banks offered or were planning to offer blockchain processes to their customers.
With increasing advancements, blockchain’s integration into the financial sector is likely to increase.
- Blockchain
