DeFi
Sergey Kondratenko: DeFi Development Amid Increased Sanctions Risks
Fintech expert Sergey Kondratenko points out that DeFi faces unique regulatory challenges, especially in light of the increasing focus on global economic sanctions and anti-money laundering (AML) regulations. Integrating AML methods and complying with sanctions policies remain crucial issues for DeFi platforms as they strive to legitimize their operations and expand their user base.
The original philosophy of anonymity in DeFi is now being challenged. Such an approach to anonymity may need to be reconsidered if faced with a difficult choice: “one or the other.” On one side, there is the desire to maintain privacy. On the other, there is the risk of DeFi being abused to circumvent sanctions and engage in illegal financial operations, fraud, money laundering, and terrorist financing.
“Blockchain can technically guarantee a higher level of transparency than the traditional banking system. It is impossible to falsify or retrospectively change a blockchain transaction,” comments Sergey Kondratenko.
If the issue of integration into the global financial system is raised, then in the context of the universal global fight against money laundering and financial crimes, DeFi can provide much more transparency with proper adaptation.
Growing Interest in DeFi Amid Sanctions and Regulatory Restrictions
The anonymous nature of DeFi makes it attractive for money laundering, illegal financial operations, and sanctions evasion, among other things.
“Cryptocurrencies allow for easy and fast transfer of large sums of money, which can be accessed anywhere in the world,” recalls Sergey Kondratenko.
At the same time, decentralized finance tools are often used to circumvent sanctions because of their ability to provide financial services without centralized control. This allows users to make transactions anonymously, making it harder for regulators to track and block funds.
The use of DeFi for such purposes undermines the effectiveness of international economic sanctions designed to prevent unwanted political and economic actions. In response, international organizations like the FATF Authorities are currently developing guidelines and measures to regulate the DeFi sector to prevent its use to circumvent sanctions. In 2019, the Financial Action Task Force (FATF) expanded its anti-money laundering and counter-terrorist financing measures, including to the virtual asset sector and virtual asset service providers (VASPs).
Sergey Kondratenko: Challenges and Opportunities for DeFi in the Context of Global Economic Sanctions
To reduce systemic risks to the global financial system, it is necessary to address the problem of DeFi abuse to circumvent restrictions and financial crimes, track transactions, and verify financial activity.
Adopted by the European Union in July 2018, the Fifth European Anti-Money Laundering Directive (AMLD5) extends transparency requirements and anti-financial crime measures to virtual assets and their intermediaries, including DeFi platforms.
According to the directive, virtual currency operators must implement strict KYC and AML procedures, conduct thorough customer checks, keep records of financial transactions and report suspicious activities to relevant authorities.
Sergey Kondratenko notes that in order to comply with the requirements of the directive, DeFi platforms will have to find innovative solutions in the field of regulatory compliance that simultaneously ensure transparency and respect for user privacy.
In July 2023, the US Senate also approved amendments to the NDAA aimed at tightening control over cryptocurrency mixers, anonymous coins, and organizations working in the digital asset sector. In addition, US authorities proposed a bill requiring DeFi protocols to implement fight against money laundering (AML). In Europe, the European Parliament’s Economic and Home Affairs Committees have also backed a bill that extends AML requirements to DAOs and other Web3 platforms. Under the bill, all transactions over €1,000 must be subject to mandatory monitoring.
Considering all this, despite the philosophy of anonymity, DeFi platforms are exploring ways to integrate anti-money laundering principles into their operations.
Blockchain’s technological transparency can be used to develop more reliable anti-money laundering tools and compliance requirements that track and analyze transactions more efficiently than traditional systems.
Sergey Kondratenko notes that DeFi can play a key role in combating money laundering and preventing illegal financial transactions on a global scale.
With blockchain transparency, DeFi platforms can offer new ways to monitor and protect financial transactions. Smart contracts, for example, can be programmed to reject transactions that don’t meet specific legal criteria, effectively automating compliance and reducing human error.
Prospects for integrating DeFi into traditional financial infrastructure under sanctions – Sergey Kondratenko
The integration of DeFi into the traditional financial system opens up significant opportunities and serious challenges. For DeFi to be fully compliant with anti-money laundering and counter-terrorist financing requirements, it must overcome several obstacles:
Strengthened KYC measures. DeFi platforms must develop mechanisms that ensure proper verification of all users while adhering to the principles of decentralization.
Interaction with regulatory authorities. Continued dialogue with regulators will be crucial to align DeFi developments with the existing legal basis and potentially influence the creation of new rules that recognize the unique aspects of decentralized systems.
Standardization of protocols. Establishing standard protocols across different platforms can help ensure consistent application of compliance measures, simplifying integration with traditional financial systems.
As DeFi continues to grow, these efforts will be critical to defining its place in the broader financial landscape, particularly in regions that are heavily regulated and monitored for sanctions compliance.
Sergey Kondratenko added that amid tightening global sanctions and regulatory frameworks, a technology-driven approach to DeFi could be more effective since more traditional financial systems often face bureaucratic sluggishness, making them less adaptable to rapidly changing international rules.