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US Treasury Releases Decentralized Finance Illicit Finance Risk Assessment

US Treasury DeFi Illicit Finance Risk Assessment

Earlier today, the US Treasury released a press release regarding decentralized finance (DeFi). This press release is an “illicit finance risk assessment” targeting decentralized finance in specific. This is the first illicit finance risk assessment on DeFi worldwide. While such risk assessments are expected to become common now that US authorities are taking action on crypto, the crypto community did not receive this well.

According to the Treasury, there is no generally accepted definition of DeFi, however, this term often refers to automated peer-to-peer transactions done through smart contracts. At the beginning of the report, we notice that the Treasury is mainly targeting companies leveraging DeFi for personal benefit.

“This term [DeFi] is frequently used loosely by the private sector, ofter for services that are not functionally decentralized.”

Moving on, the report claims that decentralized finance is mostly used by different actors to perform illicit activities. The US Treasury mentions the Democratic People’s Republic of Korea (DPRK), ransomware attackers, scammers, cybercriminals, and thieves as the main users of DeFi. Additionally, the report states that many platforms offering DeFi services fail to implement their AML/CFT obligations. For your information, AML/CFT stands for “anti-money laundering and countering the financing of terrorism”.

“Our assessment finds that illicit actors, including criminals, scammers, and North Korean cyber actors are using DeFi services in the process of laundering illicit funds.”

Brian E. Nelson, Under Secretary of the Treasury for Terrorism and Financial Intelligence

US Treasury Proposes Government Action On Decentralized Finance

The 41-page report showcases numerous things, including three main recommendations for actions from the US government in regard to DeFi. The report states that the level of transparency provided by blockchain technology can help the government mitigate the financial risk that comes with using DeFi. However, transparency “cannot replace the importance of regulated financial intermediaries applying AML/CFT controls.”

According to the assessment, three of the main illicit finance threats are:

  1. DEXs and Cross-Chain Bridges:
    • The report states that illicit actors will often use a decentralized exchange to swap their crypto tokens. This action is allegedly an attempt to find a token that is more liquid than the one the individual/group is using so that they can easily exchange it for USD.
  2. Mixers:
    • Throughout history, crypto mixers were used for money laundering. By using a crypto mixer, criminals obfuscated the source, destination, and amount involved in crypto transactions. Additionally, this makes it hard for authorities to track down illicit transactions.
  3. Liquidity Pools:
    • Actors may use illicit proceeds in a liquidity pool – a DeFi service to provide liquidity. This way, individuals/groups can use their illicit proceeds to gain a portion of the fees in the DEX as a reward and generate passive income.

So, to counter illicit activity in decentralized finance, the US Treasury recommended six main things to the government. These actions are:

  1. Strengthen U.S. AML/CFT Supervision of “Virtual Asset” Activities
  2. Assess Possible Enhancements to the U.S. AML/CFT Regulatory Regime as Applied to DeFi Services
  3. Continue Research, Private Sector Engagement to Support Understanding of Developments in DeFi Ecosystem
  4. Continue to Engage with Foreign Partners
  5. Advocate for Cyber Resilience in Virtual Asset Firms, Testing of Code, and Robust Threat Information Sharing
  6. Promote Responsible Innovation of Mitigation Measures