The FATF asserts many DeFi platforms are not genuinely decentralized and calls for regulation to prevent criminal exploitation.
Summary
- The Financial Action Task Force (FATF) highlights that many decentralized finance (DeFi) platforms are not truly decentralized and should be regulated as virtual asset service providers.
- Only 7% of jurisdictions surveyed have enforced regulations on DeFi, with a mere two platforms ever registered.
- The FATF suggests that countries should motivate DeFi projects to incorporate anti-money laundering controls.
The Financial Action Task Force (FATF) has identified that a considerable number of decentralized finance (DeFi) platforms claim to be decentralized but are actually centralized to some extent. In a report released on Tuesday, the FATF stated that its regulatory framework applies to any DeFi platform where identifiable individuals maintain control, regardless of claims of decentralization.
The organization categorizes DeFi into three groups: platforms with identifiable controllers, those that are practically centralized but have anonymous operators, and a small number of genuinely decentralized platforms that are exempt from regulation. The FATF emphasizes that centralized elements often persist in practice, through concentrated governance tokens and administrative powers.
FATF President Giles Thomson noted that the aim of the report is to prevent criminals from exploiting new technologies for illicit activities while fostering responsible financial innovation. He underscored the need for enhanced information sharing between the public and private sectors.
Identifying Control
The report lists various indicators of control, including upgrade keys and concentrated voting power. The FATF insists that individuals who exert control—such as developers or major token holders—should be licensed and monitored like traditional financial entities. However, compliance remains low, with 93% of jurisdictions not implementing the FATF's standards for DeFi.
Only 26 out of 142 jurisdictions have assessed associated risks, and just two have registered or licensed any DeFi platforms. Although FATF guidelines are not legally binding, countries can face scrutiny for non-compliance.
Proposed Measures
The FATF advocates that countries close the regulatory gap by encouraging DeFi projects to integrate anti-money laundering features in their smart contracts, including KYC checks before certain functions can be activated. For projects that lack clear leadership, regulators are advised to target choke points like stablecoin issuers and exchanges.
If a platform refuses to comply, jurisdictions may ultimately prohibit its operations. Additionally, banks and exchanges are urged to conduct thorough due diligence on DeFi platforms they engage with.
Criminal Exploitation of DeFi
The report highlights how criminals, including state-affiliated hackers from North Korea, exploit the DeFi sector, citing two major attacks in April that resulted in over $570 million in losses. These incidents accounted for a significant portion of this year's total crypto-hacking losses.
Crackdowns on illicit activities are already underway, with U.S. prosecutors securing convictions against individuals involved in operating Bitcoin mixers. The FATF reiterates that creators and operators of DeFi code can be classified as regulated financial entities.
The total value locked in DeFi has risen to $86.6 billion, an increase of approximately 85% since 2023, with leading protocols controlling over 60% of this total. The FATF urges regulators to adopt its framework to prevent facilitating large-scale illicit finance.
