DeFi Needs to Comply With Anti-Money Laundering Rules, US Treasury Says

Daniel Flatley, Bloomberg News

The U.S. Treasury building stands in Washington, D.C., U.S., on Thursday, April 16, 2020. President Donald Trump threatened Wednesday to try to force both houses of Congress to adjourn -- an unprecedented move that would likely raise a constitutional challenge -- so that he can make appointments to government jobs without Senate approval. Photographer: Al Drago/Bloomberg , Bloomberg

(Bloomberg) -- Decentralized financial transactions, including those done with virtual currencies, need to comply with anti-money laundering and sanctions laws, the US Treasury Department said in a new report.

The 39-page report, which was commissioned by the Biden administration, concludes there are several risks associated with DeFi technology, which has no exact definition but includes self-executing transactions between two or more people based on the same blockchain technology that underpins cryptocurrencies. Those risks include abuse by “ransomware cybercriminals, thieves, scammers, and Democratic People’s Republic of Korea (DPRK) cyber actors,” according to Treasury.

The report issued Thursday comes as the US and other countries are grappling with how they should regulate cryptocurrencies and virtual assets. It recommends stricter rules for the technology and advises firms that they are required to follow already-established laws concerning money laundering and terrorist financing. Many institutions and users don’t do so, the report found.

“Capturing the potential benefits associated with DeFi services requires addressing these risks,” Brian Nelson, the Treasury undersecretary for Terrorism and Financial Intelligence, said in a statement. “The private sector should use the findings of this assessment to inform their own risk mitigation strategies and to take clear steps, in line with AML/CFT regulations and sanctions obligations, to prevent illicit actors from abusing DeFi services.”

AML/CFT refers to regulations on anti-money laundering and combating the financing of terrorism.

The report’s findings, which recommend some changes to the law, come as the Biden administration is considering a broader regulatory framework for cryptocurrencies and other forms of payment conducted with blockchain technology. The administration in September called on the Securities and Exchange Commission and other regulators to “aggressively pursue investigations and enforcement actions against unlawful practices.”

Read More: White House Calls on US Regulators to Continue Crypto Crackdown

Alex Zerden, a former Treasury official who advises cryptocurrency firms on their illicit-finance risks, said that while the broader regulation of digital assets remains a divisive legal and legislative issue, Treasury has been attempting to settle some open questions about the technology with guidance and reports like the one issued Thursday.

“Treasury remains consistent in identifying activities that are subject to AML/CFT requirements, regardless of what the activities are called,” Zerden said.

“New technologies may pose novel questions,” Zerden said in an email. But “Treasury continues to focus on the importance of public-private partnerships and the need to reach nontraditional actors who may have Bank Secrecy Act obligations.”

(Updates with comments from a former Treasury official starting in sixth paragraph)