The raft of new banking regulations following the financial crisis closed off many avenues to overly risky or illicit activities in order to create more transparency. But they also had the unintended consequence of shrinking financing options for some deserving regions, business sectors, individuals and non-profit groups, write Steve Hopkins, general counsel and COO of cryptocurrency and blockchain enterprise, Amit Sharma, founder of financial inclusion start-up FinClusive Capital, and their co-authors in this opinion piece. As an alternative to what the authors consider onerous banking regulations, they suggest that cryptocurrencies, and even initial coin offerings, can create market and counter-party confidence because their blockchain backbones can ensure that the source, use and even ultimate destination of funds is traceable.

“I’ll have grounds more relative than this — the play’s the thing wherein I’ll catch the conscience of the King.”

— Shakespeare’s Hamlet — Act 2 Scene 2

While his prowess as a poet is unparalleled, Shakespeare may have also made a great modern-day financial regulator — his passage presagesa blockchain-friendly framework capable of leading today’s fintech-based transactions out of the shadows – just as Hamlet’s gambit at ‘transparency’ ensnared poor uncle Claudius.

Hamlet’s ‘grounds more relative than’ mere suspicion were to fashion a transparent means (the troupe’s play) by which he hoped to gauge his counterparty’s role by linking the play’s murder scene (the transaction for all to see) to the ‘conscience’ of the King. Unwittingly, his uncle verified the transaction, by leaving the play, unable to breathe and thus confirming his complicity under the watchful eye of the prince.

Fast forward to the U.S. Office of the Comptroller of the Currency’s ongoing debate about the merits of a regulatory “sandbox” in which the fintech industry and the regulatory community might learn to play together and Hamlet’s device seems downright prescient. (A sandbox in this case is akin to public-private — or regulator-regulated company — skunk-works, where new technologies can be commercially developed while the risks and regulatory compliance needs are also evaluated for how they meet compliance standards.)

New technologies, products and business models can be tested in a collaborative, risk-mitigating approach to financial intermediation. Indeed, the U.K.’s Financial Conduct Authority, the U.S. Commodities Future Trading Commission LabCFTC pilot and the Consumer Financial Protection Bureau’s Project Catalyst initiatives already have sandbox play underway.

“Under these regimes, banks are legally required to ‘know’ their customers … and in all events report any ‘suspicious activity.’ “

Unfortunately, today’s dizzying and byzantine regulatory framework governing anti-money laundering (AML) and associated know-your-customer (KYC) compliance regimes is stifling. Many banks’ response has been to simply ‘de-risk’ customers — that is to exclude or deny entire groups of individuals or types of transactions because of the difficult, uncertain or expensive compliance requirements associated with their perceived level of risk.

But consider if King Claudius had not been in attendance, his foul deed may never have been discovered.  Clearly, ‘the system’ benefits from inclusion — not de-risking — because the latter drives potentially bad behaviors underground making them harder to detect and interdict. New technologies such as blockchain, advanced analytics and digital payments can facilitate trusted transactions between willing counterparties. Just this summer, Delaware passed a pioneering law that allows corporations to maintain blockchain-based shareholder lists along with other corporate records. Remarkably, for regulators, a view into on-blockchain securities transactions is accessible — in real-time.

We now stand at the crossroads of achieving the laudable twin aims of protecting financial system integrity and ensuring affordable and efficient financial access for all well-intentioned actors.

How We Got Here

In 1970, the Bank Secrecy Act (BSA) was signed into law to assist detection and combatting of money laundering and other illicit activities. It was assumed — at the time — that such requirements would not overly burden financial institutions because the banks already housed the required information.

Since the BSA, 11 more laws have added a host of additional requirements, many of which were put on steroids in a post 9/11 world applicable to both formally regulated banks and numerous types of non-bank financial intermediaries. The requirements were intended to make it riskier, costlier and more challenging for criminals, drug-money launderers, terrorist financiers, rogue states and WMD proliferators to exploit the banking system for illicit purposes.

Under these regimes, banks are legally required to “know” their customers (and although denied formally by regulators, to also show they know their customers’ customers), and in all events report any “suspicious activity” and transactions above prescribed levels. Most recently, financial institutions must know the beneficial ownership of their institutional (i.e. non-individual) customers and make sure their banking activities aren’t hiding an otherwise nefarious purpose.

As a result, global risk and compliance expenses have skyrocketed and all the while financial institutions struggle to explain how such costs positively affect their bottom-lines amidst the constant overhang of ever-rising penalties and fines for non-compliance.

De-risking – and the Resulting Devastation

As if these regulatory regimes weren’t burdensome enough, the legislative and regulatory response to the 2008 financial crisis upped the ante. Regulators and enforcement agencies across jurisdictions and spheres of influence began to impose hefty fines and sanctions — as much as $321 billion in penalties on global banks between 2009 and 2016. Worse for banks has been the tremendous reputational risks of being singled out as a supporter of terrorism and or organized crime — knowingly or unknowingly.

In response, many U.S. and European banks have severed ties with foreign correspondent banks over concerns that their — or their jurisdiction’s — AML regimes fall short of global standards. In addition, they have eschewed doing business with customers or industries that might later turn out to be suspicious.  This has been an understandably rational course of action — but with devastating results.

The result has been widespread financial exclusion — an unintended but very real consequence that has left hundreds of millions of people without safe and transparent access to banking services. Populations affected represent an expansive-range of the banking (and capital markets) ecosystem but disproportionately those who would otherwise benefit the most from inclusion. Financial exclusion has befallen not only individuals (e.g., diaspora, low/moderate income, credit invisible) and institutions (for example, international correspondent banks, money service businesses and other non-bank financial institutions such as fintech companies) but also large swaths of transaction types (for example, international remittances) and entire demographics, geographies and countries (for example, poor countries and jurisdictions considered high risk, such as East and Sub-Saharan Africa, Latin America, Mexico, and South/Southeast Asia).

Human Costs

The cost of bank de-risking has been profound. Accuity, a banking industry research group, found in May that 25% of global correspondent banking ties have been severed since 2009. Indeed, certain regions such as Africa and the Caribbean have been hit hardest, with nearly 70% of Caribbean banks reporting severance of correspondent banking relationships through 2015.

“Digital asset money transmission businesses … are eager to provide solutions for the de-risked at much lower costs and with greater transparency than traditional banks.”

Separately, a study published by the Charity and Security Network in February 2017, found 66% of charities and non-profits experiencing obstacles such as payment delays, onerous due diligence requirements and fee increases. Fully 16% of charities surveyed said they had experienced account closures or a refusal to open accounts. When operating in response to humanitarian crisis and natural disaster recovery, these circumstances prevent relief when it’s needed most.

More broadly, regional economies have been deeply affected, with exporters unable to engage in trade finance and individuals who rely on remittance payments from relatives unable to receive them. Fast forward to today, businesses dealing in new payment systems or stores of value, such as digital assets, find themselves subject to a new banking practice known as “pre-risking.”

Despite worldwide economic growth in the last two years, remittances to developing nations have declined precipitously – the only double-digit decline in recent memory, according to the World Bank. In fact, at an average of $440 billion a year (more than three times foreign aid), global remittances are a significant source of finance for poor countries, often contributing to a significant portion of their countries’ overall respective productivity — including to small and medium enterprise (SMEs) — the lifeblood of job-creation, and yet still less than 1% of SMEs in emerging markets have access to working capital.

By forcing millions out of the financial system, de-risking is having the opposite effect of what the BSA and related regulations intended: Millions of people are forced to use alternative financial services, which often include unregulated or informal means to access capital or make payments. Left to the shadows, predatory and exploitive practices abound, only exacerbating the poverty trap.

Digital Assets, Digital Solutions

It is time to re-risk — responsibly. The growing humanitarian and law enforcement problems resulting from de-risking can be turned to provide solutions for financial inclusion and financial sector integrity in tandem. If ‘sandbox’ opportunities are afforded, the private sector and government together can explore blockchain applications and the use, utility and efficacy of digital assets to meet everyday needs — both on and off formal global banking rails. Indeed, digital asset money transmission businesses and the like are eager to provide solutions for the de-risked at much lower costs and with greater transparency than traditional banks. In fact, in the blockchain sandbox, the regulatory community will likely find comfort from a de-centralized, immutable, technology based trust system — which is more difficult to hack and defraud.

“Fortunately, we now have the tools to begin to drive financial inclusion not only as a noteworthy social development goal, but as a matter of our national and international security.”

Constructed responsibly, the blockchain itself can assist not only in the transparent movement of value, but in value creation. For example, cryptocurrencies and even initial coin offerings (known as ICOs) can create market and counter-party confidence because their blockchain backbones can ensure both that the source, use and even ultimate destination of funds is traceable. Such endeavors can profoundly support excluded or underserved capital markets participants and provide innovative new companies an injection of needed operating capital.

With greater financial access comes more widespread engagement; with more widespread engagement comes more transactional activity in formal and regulated channels, which enhances financial sector transparency. Greater transparency is essential to providing stronger financial system integrity, and importantly the identification and interdiction of actual illicit financial activities.

Development Programs Need Support

The programmatic solutions — and essential data to support them — already exist.  For example, the Community Reinvestment Act, Small Business Administration and Community Development Financial institutions have many facilities created specifically to invest and service U.S. underserved and vulnerable populations, as well as to promote financial literacy. However, these tools are often overlooked because of their small size or underappreciated impact on risk and compliance management.

The reality is that financial inclusion and de-risking are two sides of the same coin — the phenomenon of banks wholesale jettisoning of certain types of customers or types of business is directly related to the compliance requirements faced and level of inclusion efforts undertaken. Importantly, there is a misperceived tension between compliance and driving financial inclusion at scale and profitably. A re-examination in this frame can advance the sector positively and reinforce the need — while identifying and employing appropriate tools — to be vigilant against illicit activities.

Technology Leading the Way

Our best bet to drive inclusion and catalyze necessary change is fintech and reg-tech innovation. We now see huge leaps in financial sector disruptors creating and transacting in “assets” and “stores of value” (e.g. cryptocurrencies), and furnishing technologies that drive transparency, and security and privacy –- the basic building blocks of secure financial intermediation.

Too often, however, these tools are discussed with regard to how they might be manipulated or exploited for nefarious purposes. That is both ironic and a shame because core attributes of blockchain technology, such as distributed trust, transparency and immutability, can also help solve cumbersome — but essential — customer due diligence, transaction monitoring and reporting requirements under the BSA. Technology can help drive secure financial intermediation that furthers regulatory and law enforcement priorities — at scale, and profitably.

Just as commercial innovators like CLEAR strengthen transportation security needs, non-bank commercial enterprises would enhance financial system integrity for all — importantly without the dependence on government institutions and tax dollars footing the (entire) bill.

In ‘sandbox’ environments, use cases can be developed to provide windows for regulators to analyze their development, integration, risks and linkages on a transactional basis, which include the following:

  • blockchain and distributed ledger for secure, immutable identification provisioning and client authentication;
  • secure payments – in-network/peer2peer (P2P) and through traditional channels – providing real-time transparency to transactions flows;
  • regulatory-technologies to automate account onboarding, management and reporting; and,
  • advanced analytics – for monitoring and predicting potential illicit financial flows, and translating such flows to value-added business intelligence for financial intermediaries

We are indeed at a cross-roads: On the one hand, our world has found itself more inter-connected on a radically personal level, and in ways that operate outside traditional borders — be they geographic, regulatory or platform specific. On the other hand, the last 10 years has seen the evolution of some of the most advanced financial technologies and analytics capabilities that allow us to do the following:

  • know more about each other while protecting personal information;
  • safely and securely exchange information and value with each other;
  • understand in real time where vulnerabilities lie; and,
  • from a regulatory point of view, interdict, in real time, activities that exploit, abuse or do us harm before they happen.

Importantly, we are just starting to see the commercial and national security benefits of greater inter-connectivity at a time when punitive enforcement efforts alone are failing to drive change. Fortunately, we now have the tools to begin to drive financial inclusion not only as a noteworthy social development goal, but as a matter of our national and international security.  A good first step? “Sandbox-play’s” the thing.


Steven Hopkins is COO and general counsel of Medici Ventures, an subsidiary focused on the advancement of blockchain technology. Medici/Overstock is a supporter of the Delaware Blockchain Initiative, referenced below. He is a frequent author on blockchain topics and teaches cryptocurrency and blockchain law at the Brigham Young University School of Law.

Amit Sharma is the founder of FinClusive Capital, a digital platform using blockchain-based tools to drive financial inclusion, build economic resilience and protect financial system integrity. He assisted in the creation of the U.S. Treasury’s Office of Terrorism and Financial Intelligence in the wake of 9/11 and has held senior positions in international banking and the U.S. government, including advisor to Treasury Secretary Henry Paulson. He teaches regularly at Georgetown University and the Middlebury Institute of International Studies in Monterey.

John A. Squires chairs the IP and emerging company practice at the law firm of Dilworth Paxson, and formerly was chief IP counsel for Goldman Sachs and is a leading expert in fintech and blockchain technologies. He was among the co-founders of Regulatory DataCorp, formed as a private sector response by 20 of the world’s top banks in the wake of 9/11.

David N. Lawrence is the founder and chief collaborative officer of the Risk Assistance Network+Exchange (RANE), and former associate general counsel and managing director at Goldman Sachs. Previously, he held various senior positions with the United States Attorney’s Office and the founder of Regulatory Data Corp.