Blockchain technology has made possible fully digitalized, secure, and decentralized interaction, offering complete traceability of transactions carried out on the network at a global level, providing them with security and transparency guarantees. Traceability and authenticity of the information are two key points for the prevention of money laundering and terrorist financing (AML&CTF), mainly in the application of KYC measures by obliged subjects.
Looking back, we can contemplate the technological changes that have taken place in recent years; from web 1.0, which only allowed reading information without the possibility of interacting, to web 2.0 which encouraged interaction and not only the reading of information in a centralized ecosystem (e.g. Google, Youtube, Facebook…); until the arrival of web 3.0, a disruptive technology that is enriched by new technologies such as Blockchain or P2P networks, to operate in a decentralized space that provides security and transparency (e.g. Decentraland, Spaiens, IDEX…).
Web 3.0 has changed the way in which users relate to companies, as well as the customer identification procedures implemented by entities, opening a new path that favors prevention and the fight against money laundering and terrorist financing.
Blockchain also offers the possibility of tokenization of shares, developing smart contracts, storing a company’s register of shareholders, certifying the content of minutes and meetings of management bodies, and legitimizing signatures, among others. Thereby common difficulties, such as the beneficial owner identification of a legal entity, become simple since those persons who hold shares or have voting rights are recorded in a transparent and traceable manner, facilitating the identification of the beneficial owner. Among all the applications that Blockchain offers us in terms of AML&CTF, in this article we will focus on Digital Identity.
The digitalization of internal procedures implemented by companies has led to digital customer identification, using Digital Identification Systems (DIS) that ensure the authenticity of documents and benefit from biometrics to confirm the customer’s identity. Correct customer identification is a key element in the prevention of money laundering and in the procedures applied by obliged subjects in this area.
In 2020 FATF (Financial Action Task Force) published a guide setting out the use of DIS in due diligence procedures applied by entities in compliance with anti-money laundering regulations (https://www.fatf-gafi.org/media/fatf/documents/recommendations/Guidance-on-Digital-Identity.pdf).
This guide focuses on the implementation of digital identification tools, both for formal customer identification and for the ongoing monitoring of the business relationship, mainly in non-face-to-face transactions. The following benefits of digital identification for AML&CTF emanate from section IV of the guide:
- Strengthening due diligence measures.
- Minimization of human error in the application of customer due diligence measures.
- Improved customer experience and cost reduction.
- Facilitates ongoing monitoring of the business relationship.
- Financial inclusion.
However, risks such as security or information access issues cannot be overlooked, which is why the implementation of digital identification systems must be done by applying a risk-based approach.
Faced with the exponential growth in the use of Blockchain technology and its multiples applications, in June 2021 the European Commission published the proposed eIDAS2 Regulation, which amends the previous Regulation 910/2014 eIDAS (electronic Identification, authentication, and trust services), which suffered from establishing an insufficient and limited framework to set up the European digital identity system.
This new proposal has been drafted with the aim of regulating a digital identity for all European citizens that allows them to access any service by digital identifying themselves through digital identity wallets which store their personal data and allow them to identify themselves electronically, so that only essential data is shared and that the data is given a higher level of security.
In particular, the proposed eIDAS2 Regulation focuses on a single digital identity system and digital identity wallets, as a new tool to ensure the security and reliability in the identification of citizens in cross-border transactions. For example, these digital identity wallets allow the storage of data such as ID cards, driving licenses, university degrees, credit cards, etc.
Although it is still under development, the proposed eIDAS2 Regulation opens a legislative path at the European level which aims to digitalize the relationship between customers and companies; non-only streamlining procedures and guaranteeing users control of their data, but also ensuring that companies can properly identify their customers. This last point is the cornerstone of money laundering prevention so the implementation by entities of a digital identification system supported by a legal framework will strengthen overall risk prevention.
Web 3.0 and digital identity have created new possibilities for the strengthening of due diligence measures applied by obliged subjects in the prevention of money laundering. Companies have digitalized their processes favoring this technology that provides greater security, traceability, and reliability to their internal procedures; improving, thanks to Blockchain, their customer identification and knowledge processes, and using digital identification systems as a complementary tools for the prevention of money laundering.
Organizations such as FATF and the European Commission have already started regulating digital identity to establish a legal framework from which any European citizen can benefit; including companies that can take advantage of Blockchain benefits for the prevention of money laundering and terrorist financing, which is an area in full swing that will bring great improvements in order to prevent money laundering.