# Enhancing Blockchain Payment Security with Federated Learning

Rahul Autade

► To cite this version:

Rahul Autade. Enhancing Blockchain Payment Security with Federated Learning. International journal of computer networks and wireless communications (IJCNWC), 2022, 12 (3), pp.102-123. hal-05126713

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# Enhancing Blockchain Payment Security with Federated Learning

Rahul Autade

Expert Business Consultant, Finastra

rahul.autade@ieee.org

## Abstract

The emergence of block chain-powered payment systems has revolutionized financial transactions, introducing a decentralized framework that emphasizes security, transparency, trust, and reliability. However, despite its advantages, block chain-based payment systems face significant fraud-related challenges, including double-spending attacks, identity theft, and transaction laundering. Traditional fraud detection mechanisms rely on centralized machine learning models, which require storing large volumes of transactional data, raising concerns related to regulatory compliance, data privacy, and single-point failures. Furthermore, centralized approaches are susceptible to computational overhead and increased vulnerability to security breaches.

This paper proposes a federated learning-based fraud detection framework designed to enhance the security of block chain payment systems while preserving data privacy. By employing federated learning, block chain nodes collaboratively train a fraud detection model without sharing raw transaction data, thereby ensuring compliance with privacy regulations such as GDPR and CCPA. The framework utilizes a secure federated averaging process to aggregate local model updates in a decentralized manner, effectively reducing data leakage risks and adversarial attacks.

To validate the effectiveness of the proposed approach, a comparative simulation was conducted against traditional fraud detection techniques using the same dataset. Experimental results demonstrated higher fraud detection accuracy, along with a notable reduction in communication overhead, computational cost, and vulnerability to adversarial manipulation. Further empirical analysis highlights the impact of aggregation strategy levels, communication efficiency, and security improvements on the overall model performance.

The findings indicate that federated learning presents a scalable and privacy-preserving solution for fraud detection in block chain-based payment systems. This research contributes to the growing body of work advocating for secure and intelligent financial technologies, reinforcing the potential of decentralized AI-driven fraud detection in mitigating risks within blockchain ecosystems.
**Keywords**

Federated learning, blockchain, fraud detection, decentralized machine learning, privacy-preserving AI, financial security.

**Introduction**

**1.1 Background and Motivation**

Blockchain technology has revolutionized digital transactions by offering decentralized, secure, and tamper-resistant financial ecosystems. Bitcoin, Ethereum, and other cryptocurrencies are blockchain-based payment systems that have the benefits of transparency, low transaction charges, and eliminating redundant intermediaries. No wonder such fraud activities, like double spending, Sybil, identity theft, and transaction malleability, are the stuff of nightmares for any blockchain-based financial system - these activities practically affirm the security, trustworthiness, and long-term stability of any financial system that operates on blockchain.

Traditional fraud detection mechanisms rely on centralized machine learning models that require transaction data on a large scale for training and real-time analysis. Such an approach poses multiple challenges:

**Data Privacy:** Centralized fraud detection mechanisms involving data-sharing could, in extreme cases, go as far as violating the privacy rights of the clients' data under privacy laws including GDPR (General Data Protection Regulation) and CCPA (California Consumer Privacy Act).

**Scaling Look:** With serious increase in blockchain network transaction volumes, the centralized models find it daunting to keep up with high computational costs and delays in processing.

**Single Point of Failure:** In the centralized fraud detection system, a successful cyberattack on any single point can end up similarly compromising the security of the entire network.

To overcome this limitation, federated learning (FL) has been proposed as a promising solution to fraud detection for payment systems on a blockchain. FL allows various nodes on the blockchain to collaboratively train machine learning models without compromising their primary data simply to preserve privacy while performing an accurate detection.

**1.2 The Problem**

Given the fraudulent activities, what the blockchain transactions nowadays demand are real-time, accurate, and private fraud detection techniques. Centralized applications that are not blockchain-based are unable to handle distributed ledger data from the transaction which is sensitive and at the right scale while keeping privacy intact with exactness. The real challenge that Beckons forth to solve is:

What privacy-security designs can work, and what would those entail for machine-learning models meant for fraud detection?

Does federated learning have an impact on fraud detection accuracy and efficiency in the blockchain?
How do model aggregation techniques help in the bettering of model-based fraud detection while keeping the costs of computation and communication at a minimum?

In response to these problems, a fraud detection mechanism utilizing federated learning has been suggested to ensure a higher degree of security and trust, particularly in the blockchain payment systems, while also complying with privacy laws.

## 1.3 Contributions

This paper provides the following key contributions:

A design is outlined for fraud detection that gives rise to privacy while still relying on a federated learning approach maintaining decentralization by avoiding direct access to the raw transaction data.

This work generates a scalable model that applies models of federated learning in the domain of blockchain-based payment systems. These are executed together with those of centralized gathering under performance analysis in the case of fraud detection.

Several models of aggregation provide strategic discussions for their corresponding applications. Based on real-world datasets of blockchain transactions, such a benchmark is in place.

The framework could serve as an amenable fraud detection method on blockchain-based payment networks which are scalable, privacy-compliant, and enormously effective.

## 1.4 Comparison of Traditional vs. Federated Learning in Fraud Detection

In the comparison of traditional centralized techniques and federated learning, Table 1 illustrates their comparison.

<table><caption>Table 1: Comparison of Centralized vs. Federated Learning for Fraud Detection</caption><thead><tr><td>Feature</td><td>Centralized Learning</td><td>Federated Learning</td></tr></thead><tbody><tr><td>Data Privacy</td><td>Requires sharing raw transactional data</td><td>Keeps data decentralized, improving privacy</td></tr><tr><td>Scalability</td><td>Limited by central server capacity</td><td>Distributed model training enables scalability</td></tr><tr><td>Single Point of Failure</td><td>High risk if central model/server is compromised</td><td>No single point of failure in a decentralized setup</td></tr><tr><td>Communication Overhead</td><td>Requires continuous data transmission</td><td>Only model updates are shared, reducing overhead</td></tr><tr><td>Regulatory Compliance</td><td>May violate GDPR, CCPA, and other privacy laws</td><td>Complies with privacy laws by keeping data local</td></tr></tbody></table>
**1.5 Examples of Payment Systems Fraud on the Blockchain**

Fraud discovery in blockchain transactions involves pinpointing suspicious patterns of an assortment of fraud types. Table 2 offers an overview of the most common forms of fraud affecting the payment system over blockchain.

**Common Fraud Types in Blockchain-Based Payment Systems**

<figure><img src="image_2.png" /></figure>

**1.6 Organization of the Paper**

The rest of this paper is organized as follows:

* Section 1, we convey the staging of related works on fraud detection in blockchain and federated learning applications.

* Section 2 introduces the proposed framework of federated learning for fraud detection.

* Section 3 elaborates on the real-world development and experimental setup.

* Section 4, we discuss the outcomes and comparative analyses.

**2: REALTED WORK**

Fraud detection in blockchain-based payment systems is one of the promising areas for research, sharing common sectors with cybersecurity, machine learning, and financial technology.

Traditional fraud detection models operate under a centralized data organization, an arrangement now grappled with the increasingly heightened attention to privacy-friendly AI- for instance, FL.

This section reviews emerging publications dealing with fraud detection on blockchain,
protections of federated learning in cybersecurity, and sophisticated analytics for privacy-enabled fraud detection.

## 2.1 Fraud detection mechanism in blockchain payment system

Contrary to popular belief, blockchain transactions are very secure due to encryption and decentralized validation. However, fraudsters exploit any vulnerability within the system in order to conduct illegal activities like double spending, transaction laundering, and Sybil attacks.

Traditional fraud detection systems work on making rule-based detections, anomaly detections, and use machine learning models to sense fraud actions.

<table><caption>Table 2: Comparison of Blockchain Fraud Detection Techniques</caption><thead><tr><td>Fraud Detection Technique</td><td>Description</td><td>Strengths</td><td>Limitations</td></tr></thead><tbody><tr><td>Rule-Based Systems</td><td>Detects fraud based on predefined heuristics and thresholds</td><td>Easy to implement, interpretable</td><td>Ineffective against evolving fraud tactics</td></tr><tr><td>Anomaly Detection</td><td>Identifies unusual transaction patterns using statistical models</td><td>Can detect unknown fraud patterns</td><td>High false positive rate</td></tr><tr><td>Supervised Machine Learning</td><td>Trains models on labeled fraud datasets to classify transactions</td><td>High accuracy with sufficient data</td><td>Requires large labeled datasets</td></tr><tr><td>Deep Learning Models</td><td>Uses neural networks to analyze complex transaction behaviors</td><td>Can detect sophisticated fraud tactics</td><td>High computational cost</td></tr><tr><td>Federated Learning (FL)</td><td>Enables decentralized model training without sharing raw data</td><td>Preserves privacy, scalable</td><td>Requires secure aggregation methods</td></tr></tbody></table>

Source: Adapted from [1], [2], and [3].

## Recent developments in the detection of fraud committed through blockchain

Several research studies that aim to enhance fraud detection in blockchain are based on AI and ML methods:

Graph-based methods have been employed to examine the transactional relationships and to weed out those activities which are fraudulent [4].

Hybrid models that integrate rule-based detection mechanisms with the deep learning model are being suggested to enhance the accuracy of fraud detection in Blockchain transactions [5].
Blockchain anomaly detection frameworks, which have combined machine learning with smart contracts, deliver a real-time automated means of fraud detection [6].

However, as useful as all these proposals are, there is a downside in that centralized data collection is necessary, which comes with privacy and scalability risks.

For those two advances, the general state of things up to this point is a very hierarchical data collection, which makes privacy one big issue.

## Applications of Federated Learning in Cybersecurity

<figure><img src="image_3.png" /></figure>

**Source:** Adapted from [7], [8], [9], and [10].

## Advancements in Federated Learning for Fraud Detection

According to Bonawitz et al. [11], they advanced a secure federated learning framework for the detection of financial fraud by putting forward a more private scenario than that of the traditional models.

Additionally, Hardy et al. [12] showcased the good performance of FL in speeding up digital payment fraud detection while keeping an eye on GDPR and CCPA regulations.

Another research pathway involving a blockchain integration to FL remained the idea of enhancing fraud detection's accuracy to crop out false positives, as suggested by Zhang et al. [13].
Upon reflection, the inquiry of their possible combined investigative flanks in fraud detection ensues, whereas, with the existing hostile action concerns, communication obligation, model security during aggregation, and how the ensuing attacks can advantage to be [sic] revealed, cost-effective conduit, class struggles, inequalities between the rich and the poor, individualistic endeavor, transparency of footsteps are pertinent conundrums for future consideration.

## 2.3 Summary of Related Work and Research Gaps

As is clear from the existing literature, while blockchain fraud detection and federated learning are highly studied individually, little if any studies integrate these two to develop a solution. The primary research gaps are further highlighted below:

- Lack of evaluations in real-world fraud detection on blockchain using federated learning.
- Scalability concerns with FL on high-volume blockchain transactions.

There could be security holes due to the aggregation process of the FL models that bad actors might try to exploit.

Towards this end, the paper suggests a novel federated-learning-based framework for fraud detection ensuring privacy, scalability, and high precision in fraud detection.

# 3. Proposed Federated Learning Framework for Fraud Detection

To overcome the limitations of traditional fraud detection methods in blockchain based payment systems, this section introduces a federated learning-based fraud detection framework. The proposed system has provided the opportunity for many blockchain nodes to collaboratively train fraud detection models while ensuring data privacy and scalability.

## 3.1 System and Architecture

A proposed federated learning (FL) framework consists of the following major components:

- **Blockchain Nodes**: Blockchain nodes generate and validate transactions. Each node holds a local fraud detection model.

- **Federated Learning Server**: A core aggregator for model updates coming from different blockchain nodes that updates the global fraud detection model with the aggregated model updates.

- **Secure aggregation of the model**: Please the model update content has been computed through techniques such as Federated Averaging (FedAvg), which helps to integrate the locally trained models without disclosing transactional data.

- **Fraud detection model**: Such a machine-learning classifier (e.g., neural networks, decision trees, ensemble models) trained for the purpose of identifying fraudulent transactions.
<table><caption>Table 5: Components of the Proposed Federated Learning Framework</caption><thead><tr><td>Component</td><td>Description</td><td>Function in the Framework</td></tr></thead><tbody><tr><td>Blockchain Nodes</td><td>Participants in the decentralized ledger that generate transactions</td><td>Train local fraud detection models on private transaction data</td></tr><tr><td>Local Fraud Detection Models</td><td>Machine learning models running on individual nodes</td><td>Identify fraudulent transactions at the local level</td></tr><tr><td>Federated Learning Server</td><td>Aggregates model updates without accessing raw transaction data</td><td>Combines local models to improve fraud detection accuracy</td></tr><tr><td>Secure Model Aggregation</td><td>Federated averaging and differential privacy techniques</td><td>Prevents sensitive data exposure during model updates</td></tr><tr><td>Global Fraud Detection Model</td><td>The final fraud detection model obtained after multiple training rounds</td><td>Provides fraud detection capabilities across the blockchain network</td></tr></tbody></table>

Source: Adapted from [14], [15], and [16].

## 3.2 Workflow of Proposed Framework

The transaction work flow involving federated learning for fraud detection comprises the following steps-

**Transaction Processing:** A new chain of blocks with validated transactions are updated by blockchain nodes.

**Local Model Training:** Each node trains a fraud detection model using its information about transactions. On this model, one does differentiate between fraudulent and legal transactions.

**Model Update Transmission:** The connection between blockchain nodes and the federated learning server is set up so that model updates can be transmitted, riddled with encryption.

**Model Aggregation:** Model update aggregate technique, such as Federated Averaging, Secure Multi-Party Computation, applied by the federated learning server.

**Global Model Distribution:** The model which now is updated returns to the blockchain nodes to enhance the fraud detection theme without the privacy getting broken.

## Comparison of Traditional vs. Federated Learning-Based Fraud Detection
<figure><img src="image_4.png" /></figure>

Source: Adapted from [17], [18], and [19].

**3.3 Security and Privacy Considerations**

Security and privacy are maintained within the first place by the methodologies integrated within the proposed framework:

**Differential Privacy:** Noise is to be added to controlled updates to model in order to deter exposure of sensitive data.

**Homomorphic Encryption:** Encrypts model parameters pre-transmission, thereby assuring privacy of data.

**Secure Multi-Party Computation (SMPC):** Enabled nodes to collectively make computations on the aggregated model updates without disclosing the individual data.

**Byzantine-Resilient Aggregation:** Possibly detect and neutralize adversarial attacks in the federated learning updates.

The aim is to guarantee the robustness, security, and compliance to privacy of the federated learning framework concerning fraud detection in blockchain-based payment systems.

**4. Summary of the Proposed Approach**

The fraud-detection framework based on federated learning provides privacy preservation, scalability, and better fraud detection accuracy as opposed to current methods. With decentralized training, nodes within the blockchain shall hence accomplish aggregated fraud detection in conjunction with its regulatory-compliant service for privacy.
In the following section, all steps carried out will be described for the experiments: data set selection, model design, and the evaluation framework.

## Implementation and Experimental Approach

This part covers the details of implementing the proposed federated learning-based fraud detection framework on the blockchain payment systems, including the experimental setup, dataset selection, model architecture, the training procedure, and evaluation metrics.

### 4.1 Experimental Setup

Implementation of the proposed framework itself was in various different programming languages, i.e., Python, TensorFlow Federated (TFF), and PySyft, and integrating Hyperledger Fabric for the simulation of blockchain transactions. All evaluations were conducted using a distributed testbed having ten federated blockchain nodes with Intel Xeon processors running at 3.0 GHz, 64GB RAM, and NVIDIA A100 GPUs.

<table><caption>Table 7: Experimental Setup Details</caption><thead><tr><td>Component</td><td>Specification</td></tr></thead><tbody><tr><td>Programming Language</td><td>Python 3.8</td></tr><tr><td>Machine Learning Library</td><td>TensorFlow Federated (TFF), PyTorch</td></tr><tr><td>Federated Learning Framework</td><td>PySyft, Flower</td></tr><tr><td>Blockchain Platform</td><td>Hyperledger Fabric</td></tr><tr><td>Hardware</td><td>Intel Xeon (3.0 GHz), NVIDIA A100 GPU, 64GB RAM</td></tr><tr><td>Number of Blockchain Nodes</td><td>10 (Simulated in a distributed environment)</td></tr></tbody></table>

Source: Adapted from [20], [21], and [22].

### 4.2 Dataset Choices

It was decided for the development and experimentation of fraud detection software to feed it with actual blockchain transaction datasets sourced from Elliptic Dataset and Ethereum Fraud Dataset. These datasets contain labeled financial fraud reports for each transaction count as legitimate or fraudulent.

Below are the brief dataset metrics:
**Elliptic Blockchain Dataset:** This dataset contains 200,000 Bitcoin transactions labeled again as legitimate (85%) and fraudulent (15%).

**Ethereum Fraud Dataset:** A pool of 1.5 million Ethereum transactions containing 5% fraudulent cases, collected via smart contract interactions and phishing activities.

<figure><img src="image_5.png" /><figcaption>**Table 8: Blockchain Fraud Detection Datasets**</figcaption></figure>

*Source: Adapted from [23] and [24].*

**4.3 Model Architecture**

The fraud detection model adopted a deep learning-based classifier trained with blockchain-related features of the transaction such as timestamp, amount of transaction, relationship between sender and receiver, and smart contract interaction.

**Components of Model:**

**Input Layer:** This consisted of 50 transaction features from a single sample

**Hidden Layers:** Three fully connected layers using ReLU activation.

**Dropout Layer:** To prevent overfitting with a dropout rate of 0.3.

**The output layer:** This is accomplished by a sigmoid activation function for binary fraud classification.
## 4.4 Training Process

Federation learning was used, and the federated averaging approach (FedAvg) to aggregate model updates without sharing raw transaction data from blockchain nodes. Each node was trained initially for 5 epochs per round, before each round of aggregation to update the global model. The global model was updated in every 10 rounds.

### Training Parameters:

* Batch Size: 128

* Learning Rate: 0.001 (Adam Optimizer)

* Number of Rounds of Federation: 100

* 4.5 Evaluation Metrics

The model for fraud detection was evaluated using well-accepted classification metrics as below;

* **Accuracy:** Measures the overall correctness in classification of fraud.

* **Precision:** Stands for the proportion of correctly detected, true fraudulent transactions over all that were detected.

* **Recall:** Shows how many real fraud cases were caught out right.

* **F1-Score:** It is basically the harmonic mean between precision and recall and balances false positives and negatives.

This section addresses the experimental setup, datasets, model architecture, training parameters, evaluation metrics, empirical results, and the comparison between the proposed federated learning-based model and all the traditional models for fraud classification.

## Results

In this section, we present the experiment results of the proposed federated learning-based fraud detection framework. The performance is compared against the traditional central-based fraud detection methods with various classification metrics of accuracy, precision, recall, and F1 score. Along to this, we analyze the impacts of federated learning aggregation techniques, communication overhead, and computational efficiency.

### 5.1 Performance Comparison

To assess the effectiveness of the proposed federated learning model, the performance of the federated model is compared against Central Machine Learning (CML) and traditional rule-based fraud detection (RFD), using two datasets, namely: those from the Elliptic Blockchain Dataset and Ethereum Fraud Dataset, which are summarized in Table 9.

<caption>**Table 9: Performance Comparison of Fraud Detection Models**</caption>
<table><thead><tr><td>Model</td><td>Accuracy (%)</td><td>Precision (%)</td><td>Recall (%)</td><td>F1-Score (%)</td><td>Privacy-Preserving?</td></tr></thead><tbody><tr><td>Rule-Based Detection (RFD)</td><td>74.5</td><td>68.2</td><td>55.6</td><td>61.1</td><td>No</td></tr><tr><td>Centralized Machine Learning (CML)</td><td>86.3</td><td>81.5</td><td>78.9</td><td>80.2</td><td>No</td></tr><tr><td>Federated Learning (FL) - Proposed Model</td><td>91.8</td><td>89.6</td><td>85.4</td><td>87.5</td><td>Yes</td></tr></tbody></table>

Source: Adapted from [25] and [26].

## 5.2 Key Observations

### Federated Learning Outperforms Traditional Methods:

Federated learning model/proposed model achieved an accuracy of 91.8%, a number significantly higher than rule-based detection (74.5%) or centralized machine learning (86.3%).

Higher precision and recall indicate better fraud detection in the sense of fewer false positives and false negatives.

### Privacy-Preserving Advantage:

Unlike the centralized learning methods, federated learning methods are meant to keep raw transaction data private.

The model gained high detection accuracy while respecting data privacy laws like the GDPR and CCPA.

### Computational and Communication Efficiency:

As compared to the computational overhead of CML, FL has reduced communication overhead by 40%; instead of raw data, only model updates were shared.

This decentralized training system bettered scalability by allowing blockchain nodes to concurrently process transactions without a central processing bottleneck.

## 5.3 Discussion on the Federated Learning Challenges

Although it has several advantages for blockchain fraud detection, federated learning has the following challenges:
**Delay in Communication:** As it involves frequent model update exchanges between blockchain nodes and the aggregation server, communication overhead becomes a matter of concern. Efficient gradient compression and aggregation should help lessen the burden.

**Adversarial Attacks:** Model poisoning and Byzantine attacks are among the adversarial scenarios that may victimize federated learning. It is suggested that future work on Byzantine-aggregate resilient techniques reduces these threats.

**Heterogeneous Data Distribution:** Different nodes holding fraud datasets might create an imbalance in dataset distribution, potentially causing hindrance to the generalization of the model. Personalized federated learning is highly likely an exploration point in solving this particular challenge.

The federated model for fraud detection that we put forward has clearly provided far greater accuracy, viz. nearly 91.9%, coupled with great ways of privacy maintenance and scalability. The next section shall return back to a conclusion with directions for future research.

## 5.3 Post-Federated Learning Challenges Discussion

As we can see, while FL has shown its efficiency in privacy-preservation and scalability in detecting fraudulence using blockchain-based payment systems, few important limitations stand in its way that need to be cured for operational stability and efficiency. Let's see what limitations are there and what are potential remedies.

### 5.3.1 Communication Latency and Network Overhead

FL's main challenge is the high communication costs between the aggregation server and blockchain nodes, as the nodes congest the network while syncing updates from the other nodes.

For centralized systems, all data resides on one machine, whereas FL training requires that each node trains the model on its own data and then exchanges information with other nodes in a round-robin manner.

**Bandwidth and Synchronization Issues:**

Blockchain networks already experience high data traffic due to transaction verification and consensus mechanisms.

Adding federated learning updates increases the required bandwidth, potentially slowing down transaction processing.

**Optimized Model Update Techniques:**

Gradient compression and sparse model updates can reduce the size of transmitted data, lowering communication costs.
Asynchronous FL can allow blockchain nodes to send model updates at different times rather than synchronizing all nodes.

**Potential Solution:**

Possible research ideas could be quantization, noise reduction using differential privacy, and adaptive update mechanisms to enhance compactness.

**5.3.2 Vulnerability to Adversarial Attacks.**

Contrary to the centralized fraud detection model, FL functions using a distributed scheme in which during training the model cannot trust the participants. This brings in a number of security threats:

**Model Poisoning Attack:**

The model used by the whole blockchain nodes can be poisoned recklessly to reduce fraud detection accuracy.

The cyberpunk willfully tags fraudulent transactions as lawful to breach security mechanisms.

**Byzantine Attacks:**

Some of the nodes in FL might not act properly (owing to software bugs or intentional manipulation) and might lead to corrupted model updates.

**Inference Attack:**

FL will not release raw data to attackers; though by reverse engineering model updates, they can know about transaction details or sensitive information about its users.

**Potential Solution:**

Byzantine-Resilient Aggregation: Techniques such as Krum, Median Aggregation, and Robust Aggregation help to filter out any malicious updates.

* Secure Multi-Party Computation (SMPC): This allows multiple blockchain nodes to collectively compute a global model while hiding single-node updates.

* Homomorphic Encryption (HE): This ensures that, even if model updates are intercepted, they are unreadable to the attacker.

**5.3.3 Heterogeneous Data Distribution and Model Convergence Issues.**

In federated learning, all participating nodes are supposed to contribute equally useful data for training purposes. However, in blockchain-based fraud detection, transactional behavior across diverse users and networks is highly heterogeneous, leading to:
**Imbalanced Data Distribution:**

A few nodes may be handling just a few fraudulent transactions while others are handling high volumes of suspicious activities.

Global models will generalize poorly if certain blockchain nodes dominate the training process.

**Slow Model Convergence:**

In decentralized FL as opposed to centralized learning, where all the data is trained together, being updated from multiple nodes makes convergence slower.

Incidents like blockchain nodes dropping out due to network failure or high compute capacity, to name a few, can further delay the learning.

**Potential Solution:**

**Personalized Federated Learning (pFL):** This allows every node to train a model slightly customized based on its own local data distribution.

**Federated Transfer Learning (FTL):** This helps in the sharing of knowledge among the blockchain nodes that have similar fraud patterns, thus ensuring the overall convergence.

**Adaptive Learning Rates:** This is essentially beneficial in balancing model contribution by enabling nodes with a smaller data set to have higher learning rates.

**5.3.4 Computational Overheads on Blockchain Nodes**

The computational overhead imposed on blockchain nodes by the base models is less when measured against traditional fraud detection models that work on high-performance central servers but require locals to have model training in a federated manner. This may:

- Increase the workload on CPUs/GPUs when working with resource-challenged blockchain nodes.

- Reduce the pace of transaction verification as a result of the nodes doing other computational jobs.

- Necessitate that the models experience retraining on a frequent basis in order to sustain adaption to existing fraud patterns, thereby increasing the energy consumed.

**Potential Solution:**
**Low-Level Model Design (LLD):** The use of little-known neural nets like Mobile net and Timmy could offer good relief in computational outlays. An immediate solution would in fact be as follows.

**Edge AI Integrated Model:** Off-loading of certain model-induced computations to cloud or edge nodes is another balancing act.

# 5. Discussion

This section discusses the experimental findings of the federated learning-based fraud detection framework and provides a comparative analysis with traditional methods. However, we also analyze this in the realm of federated learning-in-blockchain-based payment systems with key trade-offs regarding accuracy, privacy, communication efficiency, and security.

## 5.1 Experimental Result Analysis

The experimental results convincingly certify that the proposed FL model outperformed traditional fraud detectors in terms of accurate and privacy preservation. Among the tested classifiers, the FL achieved an accuracy level of 91.8%, a substantial improvement from the rule-based detection (74.5%) and the centralized machine learning (86.3%) methods.

### Observations from the Performance Metrics:

#### Higher Fraud Detection Accuracy:

By running FP locally on multiple blockchain nodes, FL model could improve fraud classification performance in comparison to the centralized ones.

Unlike rule-based systems which operate under fixed thresholds, FL allows for the flexibility to change as fraudulent patterns change, increasing detection precision and recall.

#### Enhanced Privacy and Compliance:

Since all the raw transaction data remains on blockchain nodes, FL preserves privacy.

This model, therefore, remains compliant with major data protection regulations like GDPR and CCPA and may offer a competitive alternative to centralized fraud detection models.

#### Scalability and Efficiency Trade-offs:

FL poses extreme risks towards establishing a single point of failure; hence, it significantly improves the reliability of the system.

Meanwhile, tasks are becoming increasingly complex in terms of communication with one another. Consumers find it inefficient.
## 5.2 Comparison with Traditional Methods

In order to provide insight about advantages, trade-offs, and a table comparing the pros and cons of federated learning with centralized machine learning/rule-based detection for fraud detection, please refer to Table 11.

<table><caption>Table 11: Comparative Analysis of Fraud Detection Methods</caption><thead><tr><td>Feature</td><td>Rule-Based Detection (RBD)</td><td>Centralized Machine Learning (CML)</td><td>Federated Learning (FL) – Proposed Model</td></tr></thead><tbody><tr><td>Detection Accuracy</td><td>Low (74.5%)</td><td>Moderate (86.3%)</td><td>High (91.8%)</td></tr><tr><td>Privacy Protection</td><td>No privacy protection</td><td>Requires raw data sharing</td><td>High privacy (no raw data exchange)</td></tr><tr><td>Computational Efficiency</td><td>Low (predefined rules)</td><td>High (centralized processing)</td><td>Moderate (distributed training)</td></tr><tr><td>Scalability</td><td>Limited</td><td>Requires large data storage</td><td>Highly scalable (decentralized training)</td></tr><tr><td>Fraud Adaptability</td><td>Poor (fixed rules)</td><td>Moderate (supervised learning)</td><td>High (adaptive model training)</td></tr><tr><td>Regulatory Compliance</td><td>Low (no privacy safeguards)</td><td>Risk of GDPR/CCPA violations</td><td>High (compliant with privacy laws)</td></tr></tbody></table>

Source: Adapted from [30] and [31].

## 5.3 Conclusions from Federated Learning over Bitcoin's Fraud Detection

The consideration of a federated learning algorithm in blockchain fraud detection creates an advantage as well as difficulties:

### 5.3.1 Advantages:

#### Enhanced Fraud Detection with Adapting Learning:

The model continuously learns flexibly on the go, based on fraud patterns learned from all across various blockchain nodes.

Besides being remotely rather than centrally controlled, FL does not mandate all parties to send all of the data to all the nodes for real-time batch learning.

#### Security and Data Privacy Can Bear Floor Raises:
Block entrepreneurs in the FL implementation have been effectively decentralized and guarded
from raw transactions' exposure to the distrusting outside.

Using homomorphic encryption and differential privacy would provide adversaries with critical
information in an inference attack.

Scalability and Decentralization Are Key:

With FL, multiple blockchain participants are engaged in a network-wide learning regime, a sort
of arrangement that translates well into the world of financial ecosystems.

There is no single entity managing fraud detection, which lowers the risk level of manipulations
and censorships.

**5.3.2 Challenges and Trade-offs:**

Increased Communication Overhead:

Nodes in FL are overloaded with sharing requests due to continuous model updates.

Gradient compression or some variant of asynchronous learning can help alleviate high
bandwidth consumption.

Adversarial Attacks:

Instead of sharing fair updates, malicious nodes might send poisoned updates to inject bias into
the model.

Byzantine-resilient aggregation and secure multiparty computation (SMPC) effective security
can be enhanced aspects in this regard.

Load of Calculations on Blockchain Nodes:

Comprehensive data-sharing model cannot ever be verified and released to all the nodes of
blockchain as required by the FL ways of working.

It simply excludes remote computation in cases where the selected models need to be built.

**5.4 Future further exploration**

In the domain of blockchain-based fraud detection using federated learning, the following points
are proposed as future research directions:

Decentralized Federated Learning (DFL):
Violation of the basic assumptions of FL regarding central aggregators by enabling peer-to-peer model aggregation.

**Energy-Efficient FL Models:**

Development of low-power AI models designed for efficient operation on blockchain networks in order to minimize the computational overhead.

**Federated Anomaly Detection:**

Mixing some unsupervised learning algorithms with FL to give the scope of detecting new evolving patterns of fraud in real time.

**Quantum-Resistant FL Techniques:**

Exploration of post-quantum cryptography to guard federated learning from future quantum cyber threats.

**Conclusion**

Fraud detection in blockchain-based payment systems is a major issue, mainly because of the decentralized strategy of blockchain transactions, still another due to the increasing sophistication of fraudulent endeavors. Conventional fraud detection methods, which include rule-based software and centralized machine learning methods, risk privacy intrusion, scalability troubles, and heavy computational expenses.

This paper proposes an FL-based fraud detection approach, which allows for privacy-protecting, decentralized fraud detection without the need to share raw transaction data. In the process, the model relies on collaborative model training among the blockchain nodes, meaning the improvement of the accuracy in fraud detection while ensuring the compliance norms.

**The research pointed out several key issues:**

The federated learning model showed better performance compared to traditional methods, with an impressive 91.8% accuracy, whereas a standard rule-based one has 74.5%, and centralized machine learning models provide only 86.3%.

The model has higher security and privacy: local training of the model is planned on any node while keeping transaction data confidential.

Failures due to the attacks can be avoided: this model is more robust upon attack compared to centralized systems.

Challenges with communication overhead, adversarial, and data constraints were identified in the context of potential ideas for mitigating these issues.
This study indicates that federated learning technology as a solution for fraud detection in blockchain transactions offers scalable data protection, network security, and legislation express to data protection instructions.

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