Introduction to Blockchain for Audit, Risk, and Compliance Professionals
Blockchain technology is transforming the world of audit, risk, and compliance. Decentralized, transparent, and secure, blockchain can enhance financial data’s accuracy and completeness, reduce fraud and error risk, and enable more efficient and effective audit processes — but it also introduces new risks. Because using blockchain results in automation of some processes, it has the potential to circumvent manual controls already in place.
This article explores the impact of blockchain on audit, risk, and compliance professionals’ work, focusing on four key areas: immutable transactions, smart contracts, non-fungible tokens, and Know Your Customer compliance.
A Digital Ledger
Blockchain is a digital ledger that records transactions in a way that’s secure, transparent, and tamper-proof. Each block in the chain contains a unique digital signature called a hash. Hashes ensure the authenticity and integrity of data. Once a block is added to the chain, it can’t be altered or deleted without invalidating the entire chain. This makes blockchain ideal for recording financial dealings because it provides complete and accurate records of transactions that can be accessed by multiple parties — securely and transparently.
Immutable Transactions
For audit, risk, and compliance professionals, immutability of transactions is one of blockchain technology’s key benefits. Once a transaction is recorded on the blockchain, it can’t be altered or deleted without the consent of all parties involved. This assures parties of the accuracy and completeness of data as it reduces error and fraud risks.
Immutable transactions can also improve the efficiency of audit processes. By providing auditors with complete and accurate records of all transactions, blockchain can enable real-time auditing and reduce the need for time-consuming manual reconciliations.
Smart Contracts
Smart contracts are self-executing contracts that automatically enforce the agreement’s terms when certain conditions are met. They’re stored on a blockchain to be accessed and executed by two parties securely and transparently.
Smart contracts can automate processes that are performed manually today, so they could revolutionize the way financial transactions are conducted. For example, a smart contract could automatically trigger a transfer of funds when predefined conditions are met, diminishing the need for intermediaries and increasing transactions’ speed and efficiency. Michael Arrington, founder of TechCrunch, was the first to perform a real estate transaction entirely via smart contract on the Ethereum blockchain in 2017. Propy conducted the first real estate NFT auction, enabling transparent and secure transfer of ownership without intermediaries, for a luxury apartment in Kiev, Ukraine using cryptocurrency.
Internal controls should be reevaluated to align with the blockchain technology’s unique characteristics, however, because adoption of smart contracts enables automations and reduces the need for manual controls.
Non-Fungible Tokens
Non-Fungible Tokens (NFTs) are unique digital assets stored on a blockchain. They’re one application of smart contracts, often used to represent artwork, music, and other creative content.
NFTs present unique challenges for audit, risk, and compliance professionals. Unlike traditional assets, the value of NFTs can be highly subjective and difficult to determine. Additionally, NFTs’ ownership and authenticity can be tough to verify, leading to fraud and money laundering risks. Audit, risk, and compliance professionals can engage legal and technology experts to ensure the proper valuation, ownership, and transfer of NFTs. Efforts should include developing verification and authentication controls and procedures, as well as establishing clear ownership and transfer records.
Know Your Customer Compliance
Blockchain technology can facilitate Know Your Customer (KYC) compliance by providing a secure, decentralized, and tamper-proof platform for collecting, storing, and sharing customer identification data. Financial institutions using blockchain-based KYC solutions can reduce the cost and complexity of compliance while improving the accuracy and completeness of their customer data. At the same time, blockchain technology could enable more efficient and secure sharing of KYC data among financial institutions, regulators, and law enforcement agencies. This would enhance KYC compliance and reduce the risk of financial crimes.
Adoption of blockchain-based KYC solutions raises some challenges, however. Integration of blockchain-based KYC solutions with existing systems and processes could raise technical issues. In addition, using blockchain technology for KYC could raise legal and regulatory issues related to sharing customer data among multiple parties. While the potential benefits of blockchain-based KYC solutions are significant, it’ll take careful consideration and planning to address challenges and ensure that blockchain-based KYC solutions meet legal, regulatory, and technical requirements.
Blockchain’s Potential, Blockchain’s Challenges
Blockchain technology has the potential to revolutionize how audit, risk, and compliance professionals approach their work. Immutable transactions, smart contracts, and NFTs offer benefits and challenges that warrant careful consideration and planning. While the benefits are clear, blockchain’s adoption calls for reevaluating existing controls to align them with its unique characteristics.
By taking steps to embrace the opportunities presented by blockchain technology, audit, risk, and compliance professionals can enhance financial data’s accuracy and completeness, reduce fraud and error risk, and enable more efficient and effective audit processes.
Michael Condon, CISA, CIA, Certified Blockchain Expert, is a Manager of Compliance Solutions at AuditBoard. He brings over 7 years of experience in the IT Compliance and Cybersecurity industry helping organizations build, maintain, and support their compliance programs. Connect with Michael on LinkedIn.