Criminals prefer fiat currencies over DeFi protocols, a new report by the U.S. Department of the Treasury has revealed.
In the "Illicit Finance Risk Assessment of Decentralized Finance" report published Thursday, the agency noted that scammers, thieves and other criminals had started using the DeFi technology for illicit activities but at a lower rate than fiat currencies or traditional assets.
DeFi is a sector within the cryptocurrency sphere which aims to automate and increase access to traditional finance using decentralized applications. DeFi proponents say the technology allows people to participate in financial activities without any costly middleman.
Over the past few years, crypto opponents have voiced their concerns about DeFi being used to assist criminals with transferring and laundering their illegal proceeds. The Treasury banned a DeFi app, Tornado Cash, last year after alleging North Korean hackers of using the coin-mixing protocol. Blockchain analysts said the state-sponsored hacking organization, Lazarus Group, laundered more than $96 million after hacking blockchain protocol Harmony Bridge.
The Treasury's sanction on Tornado Cash met complaints from politicians and the crypto community, who said that the action violated people's right to financial privacy. Crypto supporters argued that DeFi protocols like Tornado Cash allow people to enjoy the same privacy level provided in traditional finance as blockchain networks enable the public to easily track transactions.
Treasury undersecretary for terrorism and financial intelligence Brian Nelson said addressing the risks linked to DeFi services was necessary to obtain their potential benefits. He urged the private entities to use the findings of the recent report to develop their own risk mitigation strategies to prevent irresponsible parties from "abusing" DeFi technology.
In the report, the Treasury said many DeFi apps still failed to comply with the U.S. anti-money laundering and countering the financing of terrorism (AML/CFT) regulations, allowing the apps to be exploited by criminals.
The Treasury proposed improving the AML/CFT framework for application in the crypto industry. The government body also said it would collaborate with industry players to "support responsible innovation in the DeFi space."
Former Treasury official Alex Zerden said regulators remained divisive regarding a broad regulation of virtual assets. He added that the Treasury's recent DeFi risk report, commissioned by the Joe Biden administration, showed the agency's attempt to tackle the issue. Zerden, who now advises crypto companies on their illicit-finance risks, said the Treasury had stressed the importance of public-private coordination in improving the industry.
In addition to the Treasury, President Biden also asked other federal agencies like the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) to examine the risks of crypto in conjunction with each agency's functions.
International efforts to regulate DeFi
Last February, the international organization Financial Stability Board (FSB) announced that it would work with other international bodies to develop the appropriate DeFi regulations that could be applied across different jurisdictions.
In its report, the Switzerland-based FSB said it would explore how its policy recommendations could address risks specific to DeFi. The FSB and its partners will also examine the proper methods to address data gaps in assessing and monitoring the interconnectedness between DeFi and traditional finance. The organization argued that DeFi did not have substantial differences from traditional finance in terms of functions and risks.
Authorities around the globe have been assessing the interconnectedness of crypto and the traditional economy as many businesses and conventional banks started participating in the sector during the crypto boom in 2021.
Regulatory scrutiny on crypto intensified last year following several failures in the crypto industry. One of the most prominent cases was the implosion of the crypto exchange FTX following a bank run. FTX's failure led to the bankruptcies of several other crypto entities and also affected certain traditional banking firms.