Navigating the Complexities of Transaction Approval and Validation Flows

Designing a blockchain-based product requires extensive planning to deliver a compelling set of features with an optimal user experience. Every aspect of the product, from the user interface to backend logic, must be meticulously crafted. However, essential security and compliance measures often slip through the cracks. This blog post aims to offer a new perspective on enhancing your blockchain product’s design and architecture by incorporating some key elements.

Importance of Transaction Approval Flows, Compliance Processes, and Address Whitelisting

Transaction approval flows, compliance processes, and address whitelisting are crucial checkpoints that ensure every transaction is legitimate, secure, and adheres to application guidelines and regulations. A structured approval process prevents unauthorized transactions, reduces the risk of fraud, and allows for a detailed review of transactions based on preset criteria, such as transaction value, destination address, and anti-money laundering (AML) screening.

Approval flows also enable the segregation of duties and add an extra layer of security and accountability, ensuring that no single individual has complete control over the transaction process. Implementing transaction approval flows is essential for maintaining the integrity of blockchain-based products, safeguarding assets, and ensuring operations comply with legal and ethical standards.

Understanding Transaction Approval Flows

What is the Transaction Approval Flow?

All crypto transactions begin with a wallet, a software that holds a private and public key pair and tracks activities on its specific blockchain. Users transact by entering the destination address and amount, signing with their private key, and then the wallet signs and sends it to the blockchain. This process, although simple for individual users, may not suffice for transactions on a company’s wallet.

In company scenarios, at the point of signing a transaction and initiating on-chain activities, all internal checks for the party initiating the transaction should be completed. Thus, the entire approval process must take place off-chain before the transaction is signed. Off-chain transactions are often lengthy and complex, involving both automated and manual steps to ensure compliance with laws, company policies, security assessments, and record-keeping.

Whitelisting Addresses

Whitelisting external wallet addresses involves creating a list of approved addresses to which your wallet can send funds. This measure significantly reduces the risk of fraud and unauthorized transactions, maintaining a secure system by preventing unexpected or potentially harmful transactions. Whitelisting simplifies monitoring transactions and spotting unusual activity, essential for managing risk and enhancing security in the crypto space.

Whitelisting can be done on-chain or off-chain. On-chain whitelisting uses a smart contract to continuously update the list of approved addresses but incurs gas fees for every addition. While both methods require proper access controls, on-chain whitelisting makes the list public, which might not suit business needs for security privacy. Additionally, implementing other controls, such as limits on the amounts sent to whitelisted addresses, enhances transaction security.

Internal Transaction Validation and Security Approvals

Security is a key aspect of the transaction approval process, safeguarding against unauthorized access and fraud. Implementing a system that tests each transaction against specific rules – based on factors like asset type, amount, initiator, destination, etc. – benefits your business. These rules can range from simple (blocking transactions over a certain value) to complex (requiring multiple approvals for large transactions).

Defining which wallets these policies apply to is crucial. For example, a company may only allow internal transactions within its “hot wallets” and restrict external transactions from its main “warm wallet.” This ensures duties are divided and reduces the risk of fraudulent activities emptying the wallet.

Compliance Flow for Blockchain Products

Anti-money laundering (AML) procedures, laws, and regulations prevent criminals from disguising illegally obtained funds as legitimate income. The “Travel Rule” within AML requires financial institutions to pass on certain information about transactions and their participants when a transaction exceeds a specified amount, adding transparency and reducing the risk of illegal funds moving unnoticed.

Know Your Transaction (KYT) processes involve monitoring transactions in real-time to identify and report suspicious activities. KYT helps institutions understand the nature of transactions they process, ensuring they do not finance terrorism or partake in money laundering. Integrating services from AML and KYT providers like Chainalysis, Elliptic, and CipherTrace strengthens compliance efforts, reducing legal penalties and enhancing trust and security among users, investors, and partners.

Automation

Automation is essential for businesses operating around the clock, especially blockchain-based products. While automation addresses many operational challenges, it also poses security risks that must be managed. For instance, businesses must automate withdrawal processes through APIs, which involves securely managing API keys, allowing access only from approved IP addresses, regularly changing API keys, and controlling access permissions.

Segregation of Duties

Segregating duties in both automated and manual processes enhances security and control. In automated processes, responsibilities should be divided between two operators, ensuring all necessary approvals are secured. In manual processes, day-to-day operators should not unilaterally approve and control the flow; tasks should be distributed among multiple individuals for independent review and approval.