This article was first published on Dr. Craig Wright’s blog, and we republished with permission from the author.
Implementing anti-money laundering (AML) controls in a blockchain-based system like Bitcoin to improve traceability is a complex task that involves several issues and challenges (Hassan et al., 2019). Some of the key issues associated with such implementations include the following:
Pseudonymity and Privacy: Blockchain systems, including Bitcoin, often provide a level of pseudonymity, where users are identified by cryptographic addresses instead of their real-world identities. While such pseudonymity offers privacy benefits, it can also pose challenges in implementing AML controls. For example, linking specific transactions to real-world entities becomes difficult, making tracing illicit activities and identifying money laundering patterns challenging (De Filippi, 2016).
The Decentralized Nature of Blockchain Networks: Blockchain networks operate in a decentralized manner, where no central authority has full control. This decentralized nature can create hurdles in implementing AML controls effectively. Decision-making processes, regulatory compliance, and enforcement become more complex in the absence of a centralized governing body or regulatory framework (Laroiya et al., 2020).
The Lack of Standardized AML Frameworks: Blockchain technology is still relatively new, and there is a lack of standardized AML frameworks specifically tailored for blockchain-based systems (König et al., 2020). Traditional AML frameworks may not fully align with the unique characteristics of blockchain networks, requiring the development of new approaches and regulatory guidelines (Al-Tawil, 2022).
Cross-Border Transactions: Blockchain systems enable borderless and frictionless transactions, allowing users to transfer funds across jurisdictions easily (Omarova, 2020). Yet, such capability poses challenges regarding international cooperation and the harmonization of AML regulations. Countries have varying AML requirements, making ensuring consistent compliance and traceability in cross-border transactions difficult (Muirhead & Porter, 2019).
Technical Limitations: Blockchain systems, particularly public and permissionless networks, face technical limitations when it comes to scalability and transaction speed because of imposed conditions. Implementing robust AML controls requires processing many transactions quickly and efficiently, which can be challenging in the context of a blockchain’s artificially enforced scalability constraints (Taherdoost, 2023).
Balancing Transparency and Confidentiality: Blockchain technology emphasizes transparency by making transaction data publicly accessible. Yet, AML controls often involve sensitive information and confidentiality requirements. Striking a balance between the need for transparency in traceability and maintaining confidentiality for certain aspects of AML investigations can be a complex task (Pocher & Veneris, 2022).
Addressing such issues requires collaboration among regulators, blockchain developers, and industry stakeholders, to develop innovative solutions and establish regulatory frameworks specific to blockchain-based systems. In addition, it is essential to balance enhancing traceability and privacy, ensuring cross-border cooperation, and adapting AML controls to the unique characteristics of blockchain networks.
Al-Tawil, T. N. (2022). Anti-money laundering regulation of cryptocurrency: UAE and global approaches. Journal of Money Laundering Control, ahead-of-print(ahead-of-print). https://doi.org/10.1108/JMLC-07-2022-0109
De Filippi, P. (2016). The Interplay between Decentralization and Privacy: The Case of Blockchain Technologies (SSRN Scholarly Paper No. 2852689). https://papers.ssrn.com/abstract=2852689
Hassan, M. U., Rehmani, M. H., & Chen, J. (2019). Privacy preservation in blockchain based IoT systems: Integration issues, prospects, challenges, and future research directions. Future Generation Computer Systems, 97, 512–529. https://doi.org/10.1016/j.future.2019.02.060
König, L., Korobeinikova, Y., Tjoa, S., & Kieseberg, P. (2020). Comparing Blockchain Standards and Recommendations. Future Internet, 12(12), 222. https://doi.org/10.3390/fi12120222
Laroiya, C., Saxena, D., & Komalavalli, C. (2020). Chapter 9—Applications of Blockchain Technology. In S. Krishnan, V. E. Balas, E. G. Julie, Y. H. Robinson, S. Balaji, & R. Kumar (Eds.), Handbook of Research on Blockchain Technology (pp. 213–243). Academic Press. https://doi.org/10.1016/B978-0-12-819816-2.00009-5
Muirhead, J., & Porter, T. (2019). Traceability in global governance. Global Networks, 19(3), 423–443. https://doi.org/10.1111/glob.12237
Omarova, S. T. (2020). Technology v Technocracy: Fintech as a Regulatory Challenge. Journal of Financial Regulation, 6(1), 75–124. https://doi.org/10.1093/jfr/fjaa004
Pocher, N., & Veneris, A. (2022). Privacy and Transparency in CBDCs: A Regulation-by-Design AML/CFT Scheme. IEEE Transactions on Network and Service Management, 19(2), 1776–1788. https://doi.org/10.1109/TNSM.2021.3136984
Taherdoost, H. (2023). Smart Contracts in Blockchain Technology: A Critical Review. Information, 14(2), 117. https://doi.org/10.3390/info14020117
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