Tag Archives: Blockchain

Managing Disruption

Technology risks are evolving and changing so rapidly, it’s more difficult for management to assess new fraud threats and to adjust its strategies to manage and mitigate them. Applications that use disruptive technologies, such as artificial intelligence, advanced robotics, 3D printing, blockchain, and the Internet of Things, are being designed quickly and often generate new high-growth markets. CFEs and other anti-fraud professionals are struggling to stay abreast of the most recent developments and to identify anti-fraud policies, procedures and controls that add value.  Additionally, the exponential growth of computing power has enabled our client organizations to capitalize on the use of mobile devices and to leverage the ubiquity of the internet to reach their markets almost instantly.

While this is an exciting and challenging opportunity for marketers and business managers, it has injected new risk considerations for CFEs. Digitalization of data has created opportunities for knowledgeable investigators to improve their use of data analytics, use algorithms to facilitate cognitive intelligence, and to even create bot applications that perform automated fraud assessment tasks in real time. The essence of the risks and controls involved has not changed as much as the underlying technology. The new processes still need to adhere to organizational policies and procedures, change management practices are still a vital component in transitioning to new tools and processes, and system and access controls must continue to be enforced. However, some controls that were important in the past now take on a new level of criticality. Automated algorithms result in less transparency of the underlying process. When data is used and shared through these processes, accuracy and completeness become a necessity. An organization needs very specific controls to ensure a bot does not proliferate erroneous data. Anti-fraud focused information security and access control processes must treat the bot as if it were a person and only allow it access to appropriate data. Checks and balances must be integrated into the process to ensure the results are accurate, service level agreements are met, and contracts remain faithfully performed.

Advanced materials, 3D printing, and autonomous vehicles are other advances that are transforming the fraud prevention landscape. New businesses created by these technologies need to follow established governance processes and design fraud and abuse risk management and related internal controls into their business processes. As entirely new markets and products are developed, it’s important that risk managers with fraud investigation experience are involved proactively from the first. This blog has devoted several recent posts to blockchain technology.  Blockchain is a distributed ledger that maintains a shared list of records. Each of these records contains time-stamped data that is encoded and linked to every other previous transaction in that chain of transactions. The decentralized and distributed storage of these records provides visibility to everyone in the network and ensures that no single entity can change any of the historical records. While blockchain is already being used in numerous applications, most notably digital currencies, many other industries are exploring the technology.  Banks are testing cross-border financial transactions, and there is much speculation about the potential to use blockchain to eliminate the middle man in real estate deals, routine contract management, stock purchases, and other similar transactions. If blockchain is effective at eliminating intermediaries, the new business model will expose all the transacting parties to new fraud risks, which were previously being addressed by the middle man.

There are several ways CFEs can proactively help manage the effect of the fraud related aspects of disruptive technologies on their client organizations. By focusing on anti-fraud assurance, providing fraud scenario insight to management, and by demonstrating proficiency and expertise in innovative technologies, fraud examiners will be able to contribute significantly to the overall fraud prevention programs of our client organizations.

For many years organizations have been encouraged by economists to focus on what they do best. That is wise advice for the fraud examination profession, as well. By continuing to focus on governance, fraud risk, and preventative controls, CFEs can help ensure fraud prevention policies and processes are designed and operating effectively. Regardless of the nature or tempo of the changes, investigators will then be able to more effectively fulfill their mission. Moreover, proactively helping their organizations anticipate emerging fraud risks and technological changes can position fraud examiners as authorities and better prepare client organizations to better respond to disruptive events.

By aligning with the expectations of the profession’s key client stakeholders and working closely with those subject-matter experts who are implementing disruptive technologies from within and without, CFEs can remain focused on the most relevant and significant fraud prevention related issues.  For example, cybersecurity and data privacy are topics that every organization is managing. Identifying trends that will affect the organization, and collaborating with and providing insight to their stakeholders, can enable the CFE community to significantly affect the business agenda.  More than ever, fraud examiners must constantly pursue training to learn about recent technologies and the complex and emerging new risks being introduced into their organizations.  Additionally, chief investigators need to focus on developing an adaptive, flexible, innovative staffing model. This new model must tap into a highly specialized talent pool that has the technological competence to rapidly understand and leverage new tools, techniques, and processes.  Perhaps the most important thing CFEs can do to prepare for disruptive technological innovations is to embrace and leverage new technologies in their own work. CFE investigators need to be at the forefront of adopting artificial intelligence, cognitive computing, and smart robots.

All assurance professionals need to completely understand how technologies like blockchain work and how they can be used and analyzed in fraud investigations.  They must take advantage of machine learning and data analytics in their examination processes. Moreover, continuous fraud auditing should be the standard default for new review routines and real-time identification of fraud signatures and red flags should be a requirement as organizations implement new business processes.

In summary, the threat of disruptive technologies has arrived and will affect every organization regardless of its size or objectives. When Gordon Moore observed in 1965 that the number of transistors on an integrated circuit had doubled every year since transistors were invented, few thought that exponential growth would continue for more than 50 years. As computing power increases, technology becomes more mobile, data becomes more accessible and usable, and fraudsters capitalize on the opportunities that arise. Fraud risk managers will have to assess emerging threats consistently and continuously. CFEs will need to respond to emerging threats with new and better ways to perform our investigations and engage to redesign our own processes or face disruption ourselves.

The Anti-Fraud Blockchain

Blockchain technology, the series of interlocking algorithms powering digital currencies like BitCoin, is emerging as a potent fraud prevention tool.  As every CFE knows, technology is enabling new forms of money and contracting, and the growing digital economy holds great promise to provide a full range of new financial tools, especially to the world’s poor and unbanked. These emerging virtual currencies and financial techniques are often anonymous, and none have received quite as much press as Bitcoin, the decentralized peer-to-peer digital form of money.

Bitcoins were invented in 2009 by a mysterious person (or group of people) using the alias Satoshi Nakamoto, and the coins are created or “mined” by solving increasingly difficult mathematical equations, requiring extensive computing power. The system is designed to ensure no more than twenty-one million Bitcoins are ever generated, thereby preventing a central authority from flooding the market with new Bitcoins. Most people purchase Bitcoins on third-party exchanges with traditional currencies, such as dollars or euros, or with credit cards. The exchange rates against the dollar for Bitcoin fluctuate wildly and have ranged from fifty cents per coin around the time of its introduction to over $16,0000 in December 2017. People can send Bitcoins, or percentages of bitcoin, to each other using computers or mobile apps, where coins are stored in digital wallets. Bitcoins can be directly exchanged between users anywhere in the world using unique alphanumeric identifiers, akin to e-mail addresses, and there are no transaction fees in the basic system, absent intermediaries.

Anytime a purchase takes place, it is recorded in a public ledger known as the blockchain, which ensures no duplicate transactions are permitted. Crypto currencies are called such because they use cryptography to regulate the creation and transfer of money, rather than relying on central authorities. Bitcoin acceptance continues to grow rapidly, and it is possible to use Bitcoins to buy cupcakes in San Francisco, cocktails in Manhattan, and a Subway sandwich in Allentown.

Because Bitcoin can be spent online without the need for a bank account and no ID is required to buy and sell the crypto currency, it provides a convenient system for anonymous, or more precisely pseudonymous, transactions, where a user’s true name is hidden. Though Bitcoin, like all forms of money, can be used for both legal and illegal purposes, its encryption techniques and relative anonymity make it strongly attractive to fraudsters and criminals of all kinds. Because funds are not stored in a central location, accounts cannot readily be seized or frozen by police, and tracing the transactions recorded in the blockchain is significantly more complex than serving a subpoena on a local bank operating within traditionally regulated financial networks. As a result, nearly all the so-called Dark Web’s illicit commerce is facilitated through alternative currency systems. People do not send paper checks or use credit cards in their own names to buy meth and pornography. Rather, they turn to anonymous digital and virtual forms of money such as Bitcoin.

A blockchain is, essentially, a way of moving information between parties over the Internet and storing that information and its transaction history on a disparate network of computers. Bitcoin, and all the other digital currencies, operates on a blockchain: as transactions are aggregated into blocks, each block is assigned a unique cryptographic signature called a “hash.” Once the validating cryptographic puzzle for the latest block has been solved by a coin mining computer, three things happen: the result is time-stamped, the new block is linked irrevocably to the blocks before and after it by its unique hash, and the block and its hash are posted to all the other computers that were attempting to solve the puzzle involved in the mining process for new coins. This decentralized network of computers is the repository of the immutable ledger of bitcoin transactions.  If you wanted to steal a bitcoin, you’d have to rewrite the coin’s entire history on the blockchain in broad daylight.

While bitcoin and other digital currencies operate on a blockchain, they are not the blockchain itself. It’s an insight of many computer scientists that in addition to exchanging digital money, the blockchain can be used to facilitate transactions of other kinds of digitized data, such as property registrations, birth certificates, medical records, and bills of lading. Because the blockchain is decentralized and its ledger immutable, all these types of transactions would be protected from hacking; and because the blockchain is a peer-to-peer system that lets people and businesses interact directly with each other, it is inherently more efficient and  cheaper than current systems that are burdened with middlemen such as lawyers and regulators.

A CFE’s client company that aims to reduce drug counterfeiting could have its CFE investigator use the blockchain to follow pharmaceuticals from provenance to purchase. Another could use it to do something similar with high-end sneakers. Yet another, a medical marijuana producer, could create a blockchain that registers everything that has happened to a cannabis product, from seed to sale, letting consumers, retailers and government regulators know where everything came from and where it went. The same thing can be done with any normal crop so, in the same way that a consumer would want to know where the corn on her table came from, or the apple that she had at lunch originated, all stake holders involved in the medical marijuana enterprise would know where any batch of product originated and who touched it all along the way.

While a blockchain is not a full-on solution to fraud or hacking, its decentralized infrastructure ensures that there are no “honeypots” of data available, like financial or medical records on isolated company servers, for criminals to exploit. Still, touting a bitcoin-derived technology as an answer to cybercrime may seem a stretch considering the high-profile, and lucrative, thefts of cryptocurrency over the past few years. Its estimated that as of March 2015, a full third of  all Bitcoin exchanges, (where people store their bitcoin), up to then had been hacked, and nearly half had closed. There was, most famously, the 2014 pilferage of Mt. Gox, a Japanese based digital coin exchange, in which 850,000 bitcoins worth $460,000,000 disappeared. Two years later another exchange, Bitfinex, was hacked and around $60 million in bitcoin was taken; the company’s solution was to spread the loss to all its customers, including those whose accounts had not been drained.

Unlike money kept in a bank, cryptocurrencies are uninsured and unregulated. That is one of the consequences of a monetary system that exists, intentionally, beyond government control or oversight. It may be small consolation to those who were affected by these thefts that the bitcoin network itself and the blockchain has never been breached, which perhaps proves the immunity of the blockchain to hacking.

This security of the blockchain itself demonstrates how smart contracts can be written and stored on it. These are covenants, written in code, that specify the terms of an agreement. They are smart because as soon as its terms are met, the contract executes automatically, without human intervention. Once triggered, it can’t be amended, tampered with, or impeded. This is programmable money. Such smart contracts are a tool with the potential to change how business in done. The concept, as with digital currencies, is based on computers synced together. Now imagine that rather than syncing a transaction, software is synced. Every machine in the network runs the same small program. It could be something simple, like a loan: A sends B some money, and B’s account automatically pays it back, with interest, a few days later. All parties agree to these terms, and it’s locked in using the smart contract. The parties have achieved programmable money!

There is no doubt that smart contracts and the blockchain itself will augment the trend toward automation, though it is automation through lines of code, not robotics. For businesses looking to cut costs and reduce fraud, this is one of the main attractions of blockchain technology. The challenge is that, if contracts are automated, what will happen to traditional firm control structures, processes, and intermediaries like lawyers and accountants? And what about managers? Their roles would all radically change. Most blockchain advocates imagine them changing so radically as to disappear altogether, taking with them many of the costs currently associated with doing business. According to a recent report in the trade press, the blockchain could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading, and regulatory compliance by $15-20 billion per annum by 2022.  Whereas most technologies tend to automate workers on the periphery, blockchain automates away the center. Instead of putting the taxi driver out of a job, blockchain puts Uber out of a job and lets the taxi drivers work with the customer directly.

Whether blockchain technology will be a revolution for good or one that continues what has come to seem technology’s inexorable, crushing ascendance will be determined not only by where it is deployed, but how. The blockchain could be used by NGOs to eliminate corruption in the distribution of foreign aid by enabling funds to move directly from giver to receiver. It is also a way for banks to operate without external oversight, encouraging other kinds of corruption. Either way, we as CFEs would be wise to remember that technology is never neutral. It is always endowed with the values of its creators. In the case of the blockchain and crypto-currency, those values are libertarian and mechanistic; trust resides in algorithmic rules, while the rules of the state and other regulatory bodies are often viewed with suspicion and hostility.