Regtech and Cryptocurrency: Importance, Regulation, and More

September 7, 2022

The advent of Regtech has fundamentally changed the way Fintechs operate, automating much of the regulatory process for Risk and Compliance teams.

While implementing Regtech software does have challenges, once perfected it can save time and money at scale, while also keeping track of regulatory changes and ensuring the platform’s tech stack remains compliant.

Given the rapid pace of innovation in Fintech, it’s no surprise that Regtech solutions have begun to leverage modern technology to automate processes like record keeping. While not commonly used in traditional banking, many Fintech platforms have adopted Regtech solutions that leverage the blockchain to improve their KYC and AML processes. Cryptocurrency platforms themselves can use Regtech to make sure they follow AML compliance regulations.

To help you learn how Regtech and crypto are related - and how you can use them to transform identity verification, transaction monitoring, and case management across the Fintech industry - we’ll cover the following topics:

Before we discuss the use cases for Regtech in cryptocurrency, let’s explore how blockchain technology can change the banking industry.

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The Blockchain and Banking

In traditional banking, there are several procedures that can be time-consuming and costly. The introduction of the blockchain presents a solution for many of the procedural issues found in banking.

Incorporating a blockchain system gives banks access to data needed to accelerate the speed of customer transactions - from everyday purchases to cross-border money transfers. Automating these processes eliminates the need for manual labor, and the decentralized network gives FIs the assurance that the data is secure and current.

To understand how blockchains can improve banking, here is a quick primer on blockchain technology:

  • A blockchain is a decentralized ledger, which can be made accessible to all FIs and relevant agencies within the banking industry.
  • Blocks can store a wide range of relevant information - from a customer’s transactional data from their bank(s) to formal records of their financial history and non-financial information. This can help banks obtain information for different due diligence processes without needing a third party.
  • The information stored on the blocks is immutable and any material changes to the underlying information are made available network wide almost instantaneously, keeping the network accurate and updated.
  • Every block on the network is cryptographically encrypted using a ‘hash’ - the result of a mathematical algorithm. In the event data in the network is altered, the hash function will detect the change and result in a failure. This means that fraudsters cannot manipulate or misuse stored customer data undetected.
  • Using the blockchain, banks can create a system with real-time access to data - reducing the amount of time and energy needed to approve transactions and complete complex procedures.
  • Further, the blockchain can be used to automate the execution of repetitive processes using Smart Contracts, whose efficacy is regulated by the same mathematical hash functions. 

Overall, crypto (and the blockchain) have a clear application in financial services, especially when it comes to virtual banking and investment services.

Regtech and Cryptocurrency: How the Blockchain is Changing Regulatory Tech

The manual labor required to stay on top of AML compliance and financial crime prevention has been a struggle for many FIs. Regtech has improved AML measures for Fintechs with the ability to automate these processes. By adding blockchain technology, AML specialists can take their automation a step further.

For Regtech to work, it relies on access to relevant KYC and AML data and regulations. When blockchain is incorporated into a Fintech’s compliance system, it can access immutable data quickly.

This saves Risk and Compliance teams time and energy identifying regulatory compliance issues - and allows them to dedicate more time to fixing these issues and developing their core product offerings.

Below are the ways crypto companies have used the blockchain to improve their Regtech.

1. Identity Verification and KYC Procedures

Identifying fraudulent activity at account creation is crucial to stopping money launderers in their tracks. This is why Fintechs have turned to identity verification solutions which are typically offered with Regtech software. By embedding KYC/KYB processes within their Onboarding Orchestration, their systems can access data sources that prove a user’s identity and, if compliant, automatically approve end consumers’ access to their services.

A blockchain-based system can help verify identities in near real-time, by comparing information submitted by end users with secure, up-to-date data pertaining to those users on the blockchain, and automatically execute smart contracts that approve account creation, thereby eliminating most manual verification requirements. In the rare event of escalations, such identity providers can partner with Risk and Compliance infrastructure tools to perform BSA-compliant Case Management.

2. Transaction Monitoring and Screening

Regtech has become very useful for Fintechs who have automated their fraud and AML efforts with Transaction Monitoring and screening. Rulesets are created that establish what potential instances of financial crime might look like. These are then run against customer transactions and event data in real time to identify suspicious activity.

Blockchain can be used to increase the speed and security of automated transaction monitoring for crypto use cases. The inherent transparency of the blockchain means that all on-chain transactional information can be verified instantaneously. In case of data inconsistencies Risk and Compliance specialists can be engaged to review potential fraud. In all other cases, the  transaction will be processed quickly and safely.

3. Record Storage and Management

Some FIs have been able to use Regtech as a way of storing and accessing important records to help teams maintain compliance and manage cases of suspicious activity. However, some manual labor is still required for teams to implement an efficient workflow.

With blockchain technology, crypto companies can access secure information and trust it is up-to-date. Due to the decentralized nature of blockchain, updated KYC and regulatory data is accessible in real-time. This gives all applicable parties quick access to the data and records needed to meet regulations and properly complete all processes.

It also creates an efficient, easy-to-use ledger of all records that can’t be altered, and creates the potential for self-executing contracts based on secure algorithms.

4. Fraud Prevention and Protection

While Regtech is most commonly associated with AML compliance, the fact is, Regtech software also helps (albeit mostly indirectly) with fraud prevention and protection.

Fintechs that use Regtech have accelerated their fraud prevention strategies by automating many of their procedures throughout the customer journey. This has helped companies prevent bad actors from accessing their services and provided the ability to quickly file SARs and other reports with regulatory bodies such as FinCEN and goAML.

Blockchains take prevention a step further with cryptography. Data blocks are encrypted to keep fraudsters from accessing sensitive data. Additionally, blockchains require complete data matches from block to block. This means that fraud specialists can configure their systems to receive alerts when mismatched or seemingly synthetic data is used for account creation or transactional activity. This can help streamline the investigation process for fraud, thereby preventing fraudsters from stealing or manipulating information from crypto users.

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Regtech and Crypto: Final Thoughts

Combining Regtech with blockchain technology has the potential to transform business practices within the banking industry. Until then, it serves as a secure way of managing a transactional system.

Using Regtech software has helped cryptocurrency companies stay on top of regulatory changes in the industry (as well as improve their fraud prevention strategy). If your Risk and Compliance team is looking to improve your crypto company’s platform, Unit21 offers Risk and Compliance infrastructure that can help you improve your KYC and AML procedures. We’ve even helped companies like Bakkt reduce their false positive rates by 80%.

Schedule a demo today to learn how Unit21’s Regtech software can help you meet regulatory requirements and improve security.

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