U.s. Treasury Department Risk Assessment Emphasizes That Decentralized Crypto Companies Have Anti-money Laundering and Sanctions Compliance Obligations

• Publication year: 2023

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Jonathan R. Davey, Troy K. Jenkins, Stephen R. Heifetz, and Amy B. Caiazza ^*

In this article, the authors explain that decentralized finance companies—which are facing increased scrutiny—are often failing in meeting their obligations to address sanctions and money laundering risks.

The U.S. Department of the Treasury recently released its Illicit Finance Risk Assessment of Decentralized Finance (Assessment). ¹ The Assessment, part of a broad regulatory scrutiny of entities that operate in the decentralized finance (DeFi) space (see the explanation below), focuses on the illicit finance risks associated with virtual assets.

While the Assessment discusses how bad actors are taking advantage of weak points in anti-money laundering (AML) and other regulatory regimes across the world, we want to highlight the assessment's findings that DeFi companies are often failing in meeting their obligations to address sanctions and money laundering risks. That is significant because, among other reasons, financial institutions of all kinds are facing increased regulatory scrutiny and regulators will continue enforcement against AML infractions, especially for DeFi financial institutions.

The first-of-its-kind risk assessment alleges that DeFi service providers often fail to institute robust AML compliance programs. This, according to the Assessment, can make DeFi services vulnerable to exploitation by illicit actors. To curb the use of DeFi services for criminal activity, the Treasury's Assessment recommends that the U.S. government strengthen AML regulatory supervision,

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consider potential enhancements to the existing regulatory regime, and better engage with the private sector to stay up to date on the latest developments in the DeFi ecosystem.

De-What?

While there is no universally accepted definition of DeFi services, the term is generally used to describe virtual currency protocols and services that offer some form of automated peer-to-peer exchange transactions. Such transactions are often executed using "smart contracts" or computer code. DeFi companies can operate, at least to some extent, "without the support of a central company, group, or person," though the Treasury clarifies that "the degree to which a purported Defi service is in reality decentralized is a matter of facts and circumstances." Examples include cryptocurrency exchanges and decentralized liquidity platforms, where lenders and borrowers are incentivized to rely on a...