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Bipartisan bill introduced in US to regulate DeFi and combat digital asset crime

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A bipartisan group of U.S. senators introduced a bill requiring decentralized finance (DeFi) services to abide by the same compliance rules as financial firms, in order to prevent money laundering, digital asset-facilitated crime and sanctions violations.

Titled the Crypto-Asset National Security Enhancement and Enforcement Act of 2023 (CANSEE), the proposed legislation was introduced by Senators Jack Reed (D-RI), Mike Rounds (R-SD), Mark Warner (D-Va.) and Mitt Romney (R-UT).

“DeFi and crypto ATMs are part of a largely unregulated technology that needs stronger oversight and guardrails to prevent rampant money laundering and sanctions evasion,” Reed said. “This legislation bolsters the Treasury Department’s tools to protect our national and economic security.”

From across the aisle, Rounds added that “as more Americans start to use and invest in cryptocurrency, both DeFi platforms and crypto kiosks remain in the blind spot of regulation. This targeted legislation kicks off an important debate on how to protect our financial system and give law enforcement the tools they need to prosecute bad actors.”

The CANSEE Act would require decentralized finance services to abide by AML rules and U.S. economic sanctions, which have been areas of concern due to the unique structure of DeFi entities.

DeFi typically refers to applications and platforms that facilitate peer-to-peer financial transactions recorded on blockchains, a prominent example being decentralized exchanges such as Uniswap, where automated software allows users to trade digital assets, supposedly, without intermediaries.

This popular structure in the digital asset space has caused controversy for two main reasons. First, that decentralization often leaves firms in a legal grey area, where they act on the internet but not from any particular jurisdiction—avoiding many of the laws and rules that apply to organizations with feet on the ground in those jurisdictions. Secondly, in seeming contradiction to the first point, it’s actually still debated whether there is such a thing as being truly decentralized.

Most DeFi firms, organizations and blockchains will have ‘core developers’ who make certain decisions on behalf of the group, there is also the issue of blockchain’s consensus mechanism favoring the concentration of decision-making power in the hands of a few large coin holders or validators. Presumably these individuals will exist somewhere in the real, physical world and therefore the rules and laws of the location where they exist should, in theory, apply to the DeFi entity of which they are a part.

This confusion over the nature of DeFi has caused some difficulties when it comes to enforcing rules and laws.

According to the U.S. National Money Laundering Risk Assessment, “DeFi services often involve no AML or other processes to identify customers.” Wednesday’s press release also quoted a recent Treasury Department report, which provided a damning description of the problem:

“Illicit actors, including ransomware cybercriminals, thieves, scammers, and Democratic People’s Republic of Korea (DPRK) cyber actors, are using DeFi services in the process of transferring and laundering their illicit proceeds. To accomplish this, illicit actors are exploiting vulnerabilities in the U.S. and foreign AML regulatory, supervisory, and enforcement regimes as well as the technology underpinning DeFi services.”

To address this perceived hole in AML/CTF regulation, the CANSEE Act would end special treatment for DeFi by applying the same national security laws that apply to banks and securities brokers, casinos and pawn shops, and other digital asset companies such as centralized trading platforms.

Under the proposed rules, which have yet to be fully published, DeFi services would be forced to meet basic obligations, notably to maintain AML programs, conduct due diligence on their customers, and report suspicious transactions to FinCEN.

The legislation reportedly will also have provisions to prevent sanctioned person, such as Russian oligarch, using DeFi service to evade U.S. sanctions. In these cases, anyone who controls the offending DeFi project will be liable for facilitating that violation—if nobody “controls” a DeFi service, then a backstop is included in the bill to levy the responsibility for the obligations onto anyone who invests more than $25 million in developing the project.

The announcement of the CANSEE Act met with a swift and not wholly supportive response from some in the industry. The Crypto Council for Innovation, a “global alliance” of digital asset leaders and players, said “the proposal fails to provide a workable framework to actually address illicit finance in these sectors.”

However, the organization did also emphasize that the bill is in its early stages and “the authors are interested in a constructive dialogue.”

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