Table of Contents
In today’s world, the need for safe and secure financial transactions can’t be understated, given how everything is moving so fast and so connected.
Transactions across financial systems around the world are increasing in volume, as are the risks of fraud and financial crimes.
To tackle such problems, blockchain technology is a revolutionary type that has been altering the way to secure financial transactions and minimize the risk of fraud.
A cryptocurrency like Bitcoin or Ethereum, the underlying technology of the blockchain, is a decentralized, transparent, and safe way to record transactions.
What blockchain offers is the opportunity to fix many of the problems that are considered fraudulent, like identity theft, double spending, data breaches, etc., within the realm of financial transactions.
In this article, we shall discuss the feature and how we can prevent fraud in blockchain financial transactions.
How to Understand the Blockchain Technology
A distributed ledger technology (DLT), blockchain is essentially a method for recording data within a network of computers in a manner that cannot be modified after it has been published or shared.
Blockchain is a name for the way transactions are assembled into blocks and chained, in sequential order, to form the chain.
Each block has a set of transactions, and once a block has been placed in the chain, it’s impossible to alter or delete any block of data that it contains.
Key characteristics of blockchain technology include:
Decentralization: While blockchain works differently than traditional centralized financial systems, it does so in a decentralized way. No one has control of the system, which means no one party can manipulate or defraud the system.
Immutability: Once data is recorded on the blockchain, it becomes very difficult to alter it. Each block includes a cryptographic hash of the previous block (in this case, a series of blocks that cannot be changed without being changed electronically).
Transparency: With blockchain transactions being visible to all participants in the network, you get a very high degree of transparency. This visibility provides users with a way to verify the authenticity of transactions in real-time.
Security: Particularly when it comes to the storage of data, blockchain uses several strong cryptographic techniques to make sure only the right people can contribute to or edit transaction records. It decreases the risk of unlawful access as well as fraudulent activity.
Smart Contracts: Blockchain not only records the transactions but also supports self-executing contracts, smart contracts. The conditions under which these contracts automatically execute when certain conditions are met can be the reduction in human error or dishonesty by eliminating fraud risk.
Blockchain Preventing Financial Transactions Fraud in financial transactions can occur in a variety of ways: identity theft, phishing attacks, account takeover, insider trading, and unauthorized transfer of funds.
Blockchain solves these threats and is a good framework to combat fraud.
Some key ways in which blockchain reduces fraud in financial transactions:
• Prevention of Double-Spending
Fraud related to double spending is spending the same digital asset or currency more than once. That’s because, in traditional financial systems, double-spending can occur if it takes a long time to process transactions or if something goes wrong with the system.
The consensus mechanisms of the blockchain keep double spending from occurring by having participants in the network reach a consensus that the transactions are valid before adding them onto the blockchain.
This creates the state that when a transaction is recorded, it can never be modified or replicated.
• Improved Identity Verification
There are common forms of fraud in the financial industry; these are identity theft and account takeovers. Decentralized identity verification is a solution provided by Blockchain.
On the blockchain, people can create a fully cryptographically secured digital identity that is stored on the blockchain. It helps in taking away the dependence on centralized databases (which are vulnerable to database breaches) by implementing information and organizational logic in the application.
Secondly, the blockchain is immutable, which means that unlike any existing database, we cannot alter a user’s identity unless they give us their consent.
• Audit of Transactions
An important facet of blockchain is how transparent it is. All participants on the network can see each transaction recorded on a blockchain. It makes it easier to monitor and verify the authenticity of transactions—is the coin a legitimate Bitcoin?
Blockchains in the world of financial transactions offer impartial means for regulators, auditors, and participants to independently verify transactions in real time.
This level of visibility takes away the ability for them (whoever ‘they’ are) to do fraudulent activity because when you do it, everyone has full visibility of every transaction.
After all, it’s true for every single transaction. Particularly useful in preventing fraudulent activities like money laundering, insider trading, and accounting fraud: Blockchain’s immutable, open audit trail.
• Secure Cross-Border Payments
The nature of international financial transactions is such that they are typically subject to fraud, are carried out by large numbers of intermediaries, involve currency conversion, and foreign regulations that are different.
However, traditional cross-border payments are also slow and costly and have a greater risk for fraud, as they rely on traditional centralized financial institutions.
Removing middlemen with blockchain grants disintermediation towards the fastest, cheapest, and most secure cross-border payments.
Direct transfers between parties, which wouldn’t usually occur on a standard financial platform, make those more susceptible to fraud, which blockchain-based platforms like Ripple (XRP) can eliminate by removing middlemen and having more control of the payment process.
Moreover, the transparency and immutability of blockchain guarantee that cross-border transactions are not fraudulent and that once confirmed, such transactions cannot be reversed.
• Fraud Prevention Smart Contracts
A ‘smart contract’ is a secret marketing term for a self-executing contract that will execute the terms and conditions once a specific condition is met.
Blockchain platforms such as Ethereum run smart contracts and automate complex, time-consuming transactions without mediating any of the involved parties.
Smart contracts can ensure that fraud doesn’t occur in a transaction by ensuring that all conditions of a transaction need to be met before funds or assets are transferred.
Let me give an example: in a real estate transaction, a smart contract can be written that pays the seller automatically once the buyer’s payment is confirmed and the property’s title verified.
It reduces the risk of fraud, should a party either fail or be dishonest, as all work ‘has to be done in public.
• Cryptography for Better Security
Using advanced cryptographic techniques, blockchain is doing the security of transactions and protecting the data.
Each transaction is signed by the customer, whose cryptographic key allows the sender and authorized recipients to see or change transaction information.
That gives fraudsters another layer of protection, so they’re not able to intercept or tamper with the transaction data.
On top of that, blockchain is decentralized, and thus much harder for attackers to take control over the entire system.
Whereas centralized databases depend on only one point of failure, a blockchain-distributed network is strong; as one node is breached, the rest of the network continues to maintain security.
This will greatly reduce the chance of fraud and data breaches.
• Decentralized Consensus Mechanism
Adding to the blockchain, only valid transactions are prevented by these consensus mechanisms in fraud. For example, in proof of work, the participants (miners) must spend computational power to solve a cryptographic puzzle, and that makes it immensely expensive for fraudsters to tamper with the system.
Much like proof-of-stake, proof-of-stake guarantees that those who confirm consensus transactions have a stake in the system and that people will act in good faith.
Fraud Prevention Challenges and Limitations of Blockchain
Coming from a fraud background, blockchain certainly seems excellent in reducing fraud, but there’s a downside. Some key limitations include:
Scalability: There are scalability issues with blockchain networks of proof of work consensus. In high-volume environments, the network gets slower and pricier, becoming less effective.
Regulatory Uncertainty: As blockchain and cryptocurrency are still developing, the regulatory landscape is still forming.
However, financial regulators and governments are still trying to understand how they can integrate blockchain technology into existing laws that could hinder its wider adoption in financial transactions.
User Education and Adoption: No fraud prevention aside from blockchain is possible unless users understand how it works and how to use it securely.
Wide adoption of blockchain-based solutions may need bigger attention on the part of both the consumers and the financial institutions.
Smart Contract Vulnerabilities: It’s no secret that smart contracts can enable automated and enforced transactions, the downside is they are susceptible to bugs, coding errors, and attacks.
Malicious actors can exploit loopholes in smart contracts to execute fraudulent activities or suffer financial loss, but smart contracts help.
Conclusion
Blockchain technology is a newcomer to the field, but one that is currently making significant leaps in the fight against fraud in the financial industry.
The use of decentralization, immutability, transparency, and cryptographic security to overcome many flaws of traditional financial systems is a virtue of blockchain.
Blockchain has the potential to fight fraud and scale the financial services industry by preventing double spending, verifying identity, and providing transparent auditing between two parties.
