A recent United States Treasury Department report has spotlighted the decentralized finance (DeFi) sector, revealing its exploitation by North Korea and criminals for money laundering purposes. Although most money laundering activities still involve fiat currency or occur outside the crypto ecosystem, this development has ignited concerns about the need for tighter regulations and supervision in the DeFi space.
The US Treasury's recent report, "Illicit Finance Risk Assessment of Decentralized Finance," found that North Korean cyber actors and other criminals have exploited DeFi services' vulnerabilities to launder illicit funds. The report highlighted the insufficient Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) controls on some DeFi platforms, which enable such activities and even facilitate the theft of funds.
“Illicit actors, including criminals, scammers, and North Korean cyber actors, are using DeFi services in the process of laundering illicit funds,” according to Brian Nelson, undersecretary of the Treasury for Terrorism and Financial Intelligence. “Capturing the potential benefits associated with DeFi services requires addressing these risks.”
Some DeFi projects actively promote the absence of AML/CFT controls as a primary goal of decentralization. This lax approach allows bad actors to circumvent sanctions imposed by the US and United Nations, exacerbating the issue of illicit activities within the DeFi space.
In response to these findings, the Treasury Department has proposed several measures to enhance regulatory supervision of AML/CFT for DeFi platforms. These include providing guidance to DeFi platforms on AML/CFT compliance and addressing any existing regulatory gaps. The report pointed out that DeFi services often lack proper AML/CFT controls or customer identification processes, enabling the layering of proceeds to occur pseudonymously and instantaneously.
Figure 01. President Joe Biden's executive order or digital assets.
The assessment was conducted following President Joe Biden's executive order on digital assets, signed in March 2022. Since the order's implementation, multiple US government agencies have begun investigating the potential impact of digital assets on the country's financial system and existing payment infrastructure. In September 2022, the Treasury released a report addressing the illicit finance risks associated with crypto assets.
As the DeFi sector continues to grow and evolve, addressing the risks associated with money laundering and other illicit activities in this space is crucial. By implementing appropriate AML/CFT controls, providing guidance to DeFi platforms, and closing regulatory gaps, the industry can effectively safeguard the integrity of the DeFi ecosystem and ensure its sustainable development.