Catch Me If You Can: Fighting Fraud With Blockchain

Fraud impacts organizations of all types and sizes across a wide range of industries and geographies. Consequences can be direct, through financial losses, or indirect, through fines and reputational fallout. In 2018, firms worldwide lost more than $7 billion to internal fraud schemes, according to a “2018 Report to Nations,” by the Association of Certified Fraud Examiners (ACFE) — which analysed 2,600 real cases of occupational fraud from companies across 125 territories and 23 industries. Addressing the risk of fraud is a key challenge for all organizations.

Blockchain as a solution

Blockchain is an anti-fraud technology by design. The essence of blockchain technology is a shared and tamper-proof record of activities that are time-stamped and verified by a distributed network of computers. This provides a near real-time audit trail of information being exchanged. So, even if fraudulent information is recorded on a blockchain, there is a simple way to identify and tag the associated transactions.

In the context of digital currency payments, it is almost impossible to conduct a fraudulent transaction. The value sent from one digital currency wallet to another cannot exceed the amount recorded in the sender’s wallet. Employees working in organizations transacting in digital currency would therefore find it very difficult to tamper with payment records, thereby preventing many asset misappropriation schemes such as theft of company assets — which, according to the ACFE, represented 89% of reported fraud cases.

For organizations that don’t yet conduct payments in digital currencies (the vast majority, at present), they can still leverage the benefits of blockchain technology to disincentivize fraud. For example, when documents — such as financial statements, excel sheets or any other sensitive digital file prone to tampering — are created, edited, stored, exchanged or destroyed, such activities can be automatically “logged” on a blockchain.

The process of logging these transactions to public blockchains such as bitcoin or Ethereum is known as anchoring, whereby only the hash or cryptographic reference code pertaining to a particular activity (e.g., an email exchange) or file (e.g., a passport scan) is broadcast as part of a blockchain transaction. These blockchain transactions can then be viewable to anyone, for full public accountability, or only to those granted permission to view or access the original files for inspection, such as external auditors or regulators.

In this context, blockchain could be very effective in addressing financial statement fraud schemes, which involve overstating assets, revenues and profits, and understating liabilities, expenses and losses (or the opposite) — costing organizations a median of $800,000 per case, according to the ACFE report. Potential fraudsters that are aware of this auditability and the permanence of these records are consequently unlikely to carry out their desired schemes.

Why fraud takes place and how it is tackled

A lack of internal oversight combined with a high-pressure work environment provides the ideal conditions for organizational fraud to take place. A survey by PwC, a global auditor, showed that 52% of reported fraud cases were committed by internal actors, 24% of which were senior management. According to PwC’s “Global Economic Crime and Fraud Survey 2018” — which gathered data from 7,200 respondents across 123 different territories — usage of a blockchain-enhanced system for information exchange may help to reduce the risks and costs to reputation of senior managers committing fraud.

Currently, organizations address fraud by establishing a code of conduct, engaging with external auditors and providing authority to internal audit teams. Employing the use of data-monitoring tools and analytics also contributes to lower losses and faster detection of fraud cases, as reported by the ACFE. However, the ACFE report also cited the most common method of initial fraud detection did not rely on technology at all, but through employee tips and whistleblowing, representing 40% of cases.

Blockchain is therefore not likely to solve all types of fraud, especially those that take place primarily offline, nor does it serve to detect or predict when fraud takes place. Nonetheless, the technology’s tenets serve as a significant fraud disincentive and data integrity enforcement tool that can be used to tackle real problems, such as protecting migrant workers from corrupt employment practices and preventing tampering in real estate investment transactions.