Blockchain for Cannabis

By Sherree DeCovny, Co-Founder and Research Principal

The cannabis industry is highly decentralized because of the regulatory mandates on both the state and municipal levels. It’s fast growing: North American marijuana sales grew by 30% in 2016 to $6.7 billion, according to Arcview Market Research. It’s still emerging from the black market, which creates uncertainty about the industry.
 
Financial institutions see an opportunity to serve businesses along the cannabis supply chain, but they’re concerned about the risk, particularly because the substance is constrained at the federal level. In 2014, the Financial Crimes Enforcement Network (FinCen) issued guidance clarifying customer due diligence expectations and reporting requirements for financial institutions seeking to provide services to the cannabis industry. Yet many financial institutions don’t have the knowhow, sophistication or technology to execute on the guidance. To this end, cannabis is primarily a cash business.
 
Lamine Zarrad, a former U.S. Marine and bank examiner at the U.S. Treasury’s Office of the Comptroller of the Currency (OCC), formed Tokken to fill help this gap. He developed the Tokken mobile wallet, which consumers can use at participating retailers. At the point of sale, money is transferred from the consumer’s chosen payment account into the Tokken system. The transaction is recorded on Tokken’s blockchain-based indelible ledger, and the balance is issued to the retailer.

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What’s really interesting about Tokken is the due diligence and risk management engine behind it.
 
Zarrad discovered that the Bank Secrecy Act (BSA) is embedded in FinCen’s guidance. Introduced in 1970, the BSA was designed to help the financial sector combat money laundering associated with the Latin American drug trade. Nowadays it is a de facto tool for anti-money laundering in finance. It was amended by the U.S. Patriot Act, which effectively gave it a counterterrorism tilt, so now a person or entity that infringes upon the BSA’s framework could effectively be tried as a potential terrorist finance entity.
 
He hired Rita Crague as chief compliance officer, who previously worked for the CIA in counterterrorism finance for more than a decade. Together, they built Gestalt, an algorithm-based risk management engine that automates oversight and know your customer (KYC) processes, but also digs much deeper into the transaction chain compared to traditional systems. Essentially, Gestalt can handle two degrees of KYC: your customer and your customer’s customer. The system can go even deeper into the chain depending on the entity’s level of access and authorization. Gestalt takes terabytes of data, color-codes it and turns it to linking graphs, allowing analysts to determine whether a person or entity is good or bad.
 
Here’s how it works. Users download the Tokken app and link their bank accounts or credit or debit cards to it. By providing minimal information, Tokken can access credit data and other background checking databases to get information about that individual. It does the same thing for businesses. Entities are checked against more than 30 different international watch lists and open data sources such as social media channels, radio and TV broadcasts, and web content.
 
There’s metadata with every transaction; over 100 different points are turned into a SHA-256 encryption and anchored to the bitcoin blockchain establishing data integrity. All transactions that occur in the system are anchored to the blockchain, which gives regulators, law enforcement and auditors peace of mind that Tokken’s books can’t be cooked.
 
Essentially, Gestalt powers the analytics for KYC and BSA compliance. The blockchain serves as a redundancy mechanism or data integrity tool, and the fiat transactions occur on the front end using a PayPal-like interface for consumers and businesses.
 
In the future, Tokken hopes to replace traditional merchant processing with a cryptocurrency settlement mechanism. It also hopes to use the business intelligence from Gestalt to risk rate every transaction, and create real-time, transaction-based risk profiles as opposed to arbitrary risk models based on merchant codes.
 
Eventually, Tokken could be used for transactions along the supply chain. A business that has a Tokken account could move funds however they like. Retailers could use the account to acquire products and services and pay cultivators, manufacturers, laboratories, professional services firms and even their taxes.
 
According to Zarrad, Tokken has already raised a seed round of $1.8 million from high-profile technology experts and angel investors. Hundreds of businesses are in the pipeline, so in June 2017 Tokken was in the process of arranging a series A round for $3 million to ramp up clientele.
 
Blockchain has huge potential in the cannabis industry. Several other companies are making inroads including 420 Blockchain, which is developing a blockchain infrastructure solution to address the seed-to-sale aspect. The platform will allow growers to input relevant information about their crops and transportation companies to participate in logistics. In addition, Paragon offers data and tracking services for the cannabis supply chain, including growers, labs, doctors, retailers and customers. Chain Business Insights looks forward to monitoring blockchain implementations in this industry.