Crypto analytics firm CipherTrace is adding to its list of regulatory compliance tools with a new sanctions-friendly address tracker for decentralized exchanges (DEXs).
Announced Friday, the new DeFi Compli tool creates an oracle on Chainlink that details crypto wallet addresses on government watchlist, such as the U.S. Office of Foreign Assets Control (OFAC) sanctions list. DEXs or other decentralized smart contracts could tap these lists and prevent transactions from touching sanctioned addresses.
“What we’ve seen in the U.S. at least is really a focus on sanctions,” said John Jefferies, chief financial analyst and marketing officer for CipherTrace. “That’s the angle regulators are most concerned about right now and one of the things that has crept into the latest [Financial Action Task Force draft guidance] was proliferation financing.”
A press release announcing the new tool claimed implementing some form of crypto crime monitoring in decentralized finance (DeFi) is timely. The increasing amount of value locked in DeFi – currently some $51.4 billion, according to DeFi Pulse – presents an "even bigger target" for malicious actors, CipherTrace CEO Dave Jevans said in a statement.
More specifically, decentralized products that facilitate traditional financial activities like lending still fall within existing regulations, CipherTrace said, pointing to a 2020 speech by Securities and Exchange Commission digital asset head Valerie Szczepanik.
The regulatory crypto czar warned at the Chamber of Digital Commerce’s 2020 Parallel Summit that securities, banking, lending and anti-money laundering (AML) laws all apply to these financial activities.
Developers of DEXs or other DeFi smart contracts can set up an API call to the oracle, creating a function on their platforms that would prevent sanctioned addresses from sending funds through the DEX or contract, and similarly prevent users from sending funds to the sanctioned addresses.
“Right now we’re really looking at screening the addresses, not the individuals, so from their perspective they would on-ramp onto the DEX from their wallet, maybe from their MetaMask, [and] the DEX itself would ping the compliance oracle and say ‘is this an OFAC-sanctioned address,’” Jefferies said. “From the user perspective, unless it is an OFAC-sanctioned address, it would be transparent and frictionless.”
Jefferies said he hopes to expand the service as it evolves. While it’s only looking at specifically sanctioned sources at the moment, a future iteration could evaluate whether the source of funds is otherwise linked to illicit activity.
In his view, the crypto sector, including decentralized platforms that aspire to be stateless, must comply with regulations voluntarily or risk being shut down forcefully.
DEXs are virtual asset service providers, Jefferies said, referring to the term the Financial Action Task Force uses in its guidance around crypto exchange regulation. If the crypto sector can prove that DEXs can still comply with existing regulations, entities like FATF may focus less on carving out specific rules for developers or projects.
“Like it or not, the whole decentralized community needs to address this. Otherwise the [regulations are] going to come down in full force and the ripple effect might hit the rest of the decentralized world,” he said.
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