Optimizing KYC Verification: The Potential and Challenges of Distributed Ledger Technology in the Financial Sector

Posted in Know Your Customer (KYC) on May 9, 2024
Optimizing Kyc Verification

Optimizing KYC verification processes can greatly enhance customer onboarding efficiency and reduce operational costs for financial institutions.

Distributed Ledger Technology (DLT) looks to be the perfect solution for heritage KYC requirements. The enhanced security of the blockchain technology specifically the private, permission-based paradigm of its DLT is well matched for streamlining the KYC process. 

DLT is composed of, and only available to, a group of elected parties. Financial institutions and their clients may trust that the data in a distributed ledger both transactions and customer information is safe and will be used only for the purpose of performing KYC of customers. 

DLT is decentralized, flexible, and transparent and enables institution to share KYC data in a cost-effective and fully automated manner both among other financial services firms and with regulatory authorities. 

DLT may also flag and prevent duplicative efforts and bring increased transparency to the client-onboarding process. Moreover, monitoring a shared database of transaction history can help to spot suspicious activity.

Optimizing Kyc Verification

Optimizing KYC Verification

A consistent pain point in the AML/KYC process for firms and customers alike lies in customer verification the first step in a prospective relationship with a financial services provider which is essentially a data-collection exercise. 

The financial institutions such as banks need to know that you are who you say you are. At a minimum, a bank needs to collect your name, date of birth, and address; other possible data could include your social security number, driver’s license, and passport.

The bank then analyzes your documentation and generates an internal document certifying to regulators that you’ve been validated and that the KYC checklist process has been properly conducted. In the current setting, whenever you initiate a relationship with a different financial provider, you must repeat this process, which in turn incurs repeated costs.

With DLT, this verification process needs to happen only once. You would complete the full verification process with your “home bank.” The home bank could create a contract stored on the blockchain to contain the Proof-of-Validation document and other submitted materials. You would share the result of that initial verification with any other financial firm you intend to work with by permitting them to view your file on the blockchain. 

The smart contract could contain a record of financial firms that have checked the KYC status of this customer, and which have paid their corresponding share of the verification costs. Thus, the cost of the KYC compliance process could be shared proportionally among participating firms, which would effectively reduce the aggregate cost of the KYC process.

Ideally, the data collected and any verification forms would be standardized, so that any financial institution in the world could share the same data.

If by adopting Distributed Ledger Technology, companies could spend more time analyzing the risks of the underlying KYC and transaction data while using DLT to streamline the entire validation process, then why isn’t everyone using it? 

Even with something as obviously beneficial as employing DLT for KYC, implementing new technology for an entire industry is not without challenges. Perhaps foremost among these hurdles is that first, the financial services industry must standardize all AML/KYC language, tagging, and documentation.

And before that can happen, the participating companies must agree upon certain standard forms and procedures. And that’s just the beginning of this massive undertaking.

Optimizing Kyc Verification

Final Thoughts

Distributed Ledger Technology (DLT) presents a transformative solution to longstanding challenges in the heritage Know Your Customer (KYC) process. By offering a decentralized, flexible, and transparent system, DLT enhances security and efficiency, allowing once-off customer verification which can be universally accessed by permitted parties, mitigating repeated costs and streamlining the onboarding process. This promotes a more cost-effective and automated sharing of KYC data among financial entities and regulators.

Additionally, DLT’s potential to monitor transaction histories can aid in identifying suspicious activities. However, the pivot to this technology isn’t straightforward. Despite its evident advantages, widespread adoption necessitates industry-wide standardization and consensus on AML/KYC protocols, a mammoth task that poses significant challenges in itself.