FROM THE ARCHIVES
Zach Capers, CFE
Contributing Author, Association of Certified Fraud Examiners
The technology underlying the virtual currency bitcoin has the potential to disrupt several industries while significantly reducing fraud. Known as blockchain, the technology was created to ensure the legitimacy of every bitcoin transaction by tracking them in a distributed public ledger. Bitcoin has endured a divisive reputation due to its volatile value fluctuations and use in illicit transactions on the Deep Web; however, the security and utility offered by its blockchain is anything but controversial.
Any addition to bitcoin’s chain of information represents a new block that must be validated by every copy of the ledger spread across a worldwide computer network. Because the ledger is permanent, public and decentralized, it is incredibly difficult to defraud. These characteristics have resulted in an influx of investment and research aimed at adapting the blockchain concept to a diverse array of new applications.
Illuminating Supply Chains
The information in a blockchain can consist of anything that can be represented digitally. As such, blockchain technology can be used to ensure the authenticity and source of any number of products from organic produce to jewelry. For example, a start-up named Everledger is betting that a diamond’s myriad attributes can be recorded and tracked using an inscribed serial number and a digital blockchain to ensure that the stone being purchased is authentic.
This idea can be applied to a host of high-end goods that have typically relied on paperwork and certificates of authenticity that can be faked far more easily than a blockchain can be manipulated. Furthermore, stolen goods that are recovered can be re-authenticated to regain their value, which is important to former owners and insurance companies that have paid claims on stolen goods.
The Rise of Smart Contracts
One of the most heralded potential uses of blockchain technology is its ability to facilitate smart contracts. Rather than a standard legal contract that must be litigated or otherwise disputed if breached, a smart contract can enforce itself through digital means when preset terms are met, and revoke the contract automatically if the terms are breached.
Ethereum, a crowd-funded smart contract platform, might foretell the future of smart contracts. The network allows users to input virtually any stipulations (e.g., if this, then that) into the smart contract's blockchain and exchange value using virtual currency. For example, if one were to purchase an item from an online seller, a smart contract could be employed to hold the payment in escrow until a tracking system confirms that the item has been delivered.
Impact on Financial Institutions
A key advantage of blockchain is its ability to allow two entities that do not necessarily trust one another to trust one another. Because a blockchain can only be updated when there is consensus among the participants, the need for a third party to mediate a transaction is lessened or removed. This can alleviate many factors that complicate financial transactions (e.g., need for collateral, time required for settlements) and automate many banking processes currently requiring human interactions that add time, costs, and opportunities to commit fraud.
Stock exchanges around the world have begun to experiment with blockchains. The Japan Exchange Group announced a collaboration with IBM to test securities trading in a blockchain environment. The Australian Stock Exchange has partnered with Digital Asset Holdings, a blockchain start-up founded by well-known former JP Morgan executive Blythe Masters, to increase efficiencies related to post-trade settlements. To keep pace, the Toronto Stock Exchange hired the co-founder of aforementioned smart contract platform Ethereum to serve as the organization's first chief digital officer.
While blockchain technology is still in its infancy, it is not too early to see bitcoin as the first use case of a versatile and potentially revolutionary concept. From proving an asset’s origin to the streamlining of high finance, various new uses for blockchain continue to emerge. And while applications might vary greatly, what they all have in common are enhanced audit trails, increased efficiency and improved transparency — each of which is a known foe of fraud.
*For background on bitcoin, I recommend listening to this Fraud Talk podcast by Jacob Parks , J.D., CFE.
**This article was originally published in the ACFE's members-only monthly newsletter, The Fraud Examiner in April of 2016.