Ask an FCAT Researcher: Vanessa Kargenian on Using Blockchain to Manage Fraud and Illicit Finance

Live in-production financial service use cases are still limited, but there is growing acceptance among startups, incumbents, and regulators that blockchain technology can be used to meet regulatory compliance obligations like Know Your Customer (KYC) requirements. Vanessa compares enterprise blockchain adoption to the beginning days of electronic trading.

“When computers first arrived, it transformed our ability to interact with the stock market, but it didn’t happen overnight. The financial industry as a whole had a lot of things to work through, there were a lot of voices chiming in along the way. I feel we’re at a similar point with blockchain and enterprise adoption. The industry is wrestling with — what can and can’t the tech do? Everyone is trying to understand its limitations, and think about where it makes sense to deploy.”

Q: Blockchain didn’t arrive on the scene with KYC already baked in. How did that start to change?

A: Enterprise interest in leveraging blockchain technology for consumer, middle, and back-office operations has spurred interest in regulatory compliance. Large corporations like Fidelity have conducted blockchain experiments knowing live production use cases will require compliance. What’s changed in the last year and a half is most crypto startups have finally bought into this notion as well. Unlike the earliest crypto supporters who viewed Bitcoin as a replacement for the U.S. dollar, the industry now accepts that tokens and blockchains are alternatives, not replacements to traditional asset classes and financial technology. This means the industry is grappling with “what are the best ways to achieve regulatory compliance,” thinking through what it means from a risk perspective to incorporate tokenized assets into institutional portfolios or leverage the blockchains to realize operational efficiency.

So, a lot of decisions now are around what data goes on chain and what data goes off chain. For example, it’s very early-stage, but Coinbase has brought some KYC verifications on-chain – user account and country of residence, in an attempt to better distinguish customers from AI fraudsters and AI agents.¹

Q: Where are we now?

A: Financial service incumbents, startups, and regulators alike are working through a myriad of pilots and projects to accelerate enterprise blockchain adoption. For instance, many traditional finance firms have launched tokenization platforms and products that integrate with public chains. And the Canton Network, in league with 45 other firms, recently piloted a capital markets settlement capability across 22 independently-operated permissioned chains. Central banks and regulators too are fostering innovation by advancing pilots and clarifying rules. The EU’s enactment of Markets in Crypto-Assets (MiCA) makes KYC an explicit requirement for crypto asset service providers, while the Monetary Authority of Singapore recently completed the first phase of Global Layer One (GL1) – a DLT infrastructure layer designed to be used by regulated financial institutions.

Q: AI is everywhere these days. Are there AI-enabled blockchain solutions being used to combat fraud?

A: Absolutely. AI is being used to help enhance legacy fraud and illicit finance threat detection systems and is also being used to enhance how developers write code on a blockchain. As they are writing their code, AI can tell them where there might be a vulnerability before the code is deployed. That can help mitigate illicit finance and fraud because hackers exploit the code vulnerabilities, and if they can be detected before the code is deployed, you’re ahead of the game.

Q: What comes next?

A: There is industry-wide momentum behind designing regulatory compliant tokenized products and use cases. But the industry has stalled at a high level because there are only a handful of in-production financial service blockchain use cases. It feels like we’re all on the same page toward building toward regulatory compliance. But the question I’ve posed to my network is this: How do we build on this momentum and move beyond POCs? I think we’re going to continue to see enterprise blockchain adoption continue over the next 18 to 24 months. I’m really bullish on what the tech can do long-term.