The U.S. Department of the Treasury has released the world's first DeFi Illicit Finance Risk Assessment, examining risks associated with decentralized finance (DeFi) services. DeFi refers to virtual asset protocols and services enabling automated peer-to-peer transactions, typically through smart contracts on blockchain technology. Crypto Criminal Defense Lawyer Blog
Criminals, scammers, and North Korean cyber actors are exploiting DeFi services to launder illicit funds, taking advantage of vulnerabilities such as non-compliance with anti-money laundering (AML) and countering the financing of terrorism (CFT) regulations. Treasury Press Release
According to the Treasury Report, the primary vulnerability lies in non-compliance with AML/CFT and sanctions obligations, but other weaknesses include weak or nonexistent AML/CFT controls in other jurisdictions and poor cybersecurity controls. The Report recommends strengthening U.S. AML/CFT regulatory supervision, providing further guidance for the private sector, and assessing enhancements to address regulatory gaps.
The Treasury Report notes that the vulnerabilities in DeFi services exploited by “nation-state cyber groups” pose a threat to United States national security:
Cyber-Related Vulnerabilities
DeFi services are often particularly vulnerable to large-scale thefts due to a combination of factors, including aggregation of large amounts of funds, the lack of requirements for cybersecurity and audits in the DeFi space, concentrated administrator rights, and the availability of open-source code for DeFi services’ smart contracts. As noted above, these vulnerabilities can be exploited by hackers through security breaches, code exploits, and flash loan attacks. The documented efforts of nation-state cyber groups or other illicit actors to steal or fraudulently acquire money, including
“The documented efforts of nation-state cyber groups or other illicit actors to steal or fraudulently acquire money, including virtual assets, present a national security concern.”
virtual assets, present a national security concern. The noted cybersecurity gaps of DeFi services leave their operations vulnerable to theft and fraud, which also present risks for consumers and the virtual asset industry. Treasury Report
The U.S. Treasury's DeFi Illicit Finance Risk Assessment 39-page report outlines the abuse of decentralized finance (DeFi) services by illicit actors and identifies vulnerabilities in these services. The assessment report finds that ransomware cybercriminals, thieves, scammers, and North Korean cyber actors are exploiting DeFi services to transfer and launder illicit proceeds, particularly targeting services not compliant with existing anti-money laundering (AML) and countering the financing of terrorism (CFT) obligations.
The Bank Secrecy Act (BSA) imposes obligations on financial institutions, including DeFi services, to help detect and prevent money laundering. However, many existing DeFi services fail to comply with AML/CFT obligations, often due to a lack of understanding among industry participants.
This assessment was prompted by the findings of the 2022 National Risk Assessments (NRAs) and rising global concerns related to DeFi risks. It acknowledges that most illicit financial activities still occur through traditional methods outside the virtual asset ecosystem.
The assessment explores the market structure of the DeFi ecosystem and how threat actors misuse DeFi services for illicit activities like ransomware attacks, theft, fraud, scams, drug trafficking, and proliferation finance. It also examines vulnerabilities such as non-compliance with AML/CFT and sanctions obligations, disintermediation, and inadequate implementation of international AML/CFT standards in foreign countries.
The report includes recommendations for the U.S. government to mitigate illicit finance risks associated with DeFi services and poses questions for further consideration. The assessment report recommends strengthening U.S. AML/CFT supervision and enforcement, engaging with the industry to clarify applicable laws and regulations, and closing any identified regulatory gaps in the BSA to ensure all DeFi services are covered.
This blog post was prepared with the assistance of ChatGPT-4 AI. Nothing in this post should be considered legal advice or the creation of an attorney-client relationship. This blog is strictly for informational purposes only.
