Regulation is coming to DeFi, but can it be enforced?

Blockchain analytics company Coinfirm recently unveiled a new anti-money laundering tool for the decentralized finance, or DeFi, niche of the crypto space — a sector facing regulatory crackdown on the horizon, according to Jakub Fijolek, Coinfirm's chief technology officer. 

"DeFi might soon have some regulatory issues," Fijolek told Cointelegraph in an interview. "The amount of funds that are flowing through DeFi is growing significantly."

The DeFi niche of crypto has ballooned in 2020. In February, the total value locked in the sector reached $1 billion. Amid significant growth and interest, the niche went as high as $10 billion at one point in 2020.

During DeFi's big year, centralized exchanges have seen a few troubles, however. KuCoin faced a massive hack in September, resulting in multiple projects freezing movement on involved assets. Derivatives exchange BitMEX also suffered sizable regulatory action from the CFTC and DoJ, two U.S. governing authorities, in October, with one of its brass taken into custody. 

The KuCoin thief (or thieves) could have more proficiently used DeFi to filter the assets, making tracking more difficult, although the entity responsible reportedly did not posses significant DeFi know-how. Still, DeFi arguably remains a potential outlet to facilitate illegal activity. 

Stolen KuCoin funds making their way into DeFi is raising red flags for regulating authorities, according to Fijolek. To combat the situation, Coinfirm has built its AMLT Oracle — an anti-money laundering, or AML, tool for DeFi under its AMLT wing.

The oracle essentially can run addresses through a filter, and check whether they have been previously been associated with anything suspicious. Projects and exchanges can then freeze funds or transfers from said addresses accordingly. Fijolek explained:

"Generally, the first tool we created is the oracle, we call this [the] report oracle because it allows the generation of the same compliance report that normally centralized exchanges use, on a purely on-chain manner. So you'll send the ask transaction, as we call it, to the oracle with the report you want to get information about, and after a few blocks, you can query with the get transaction status of that address and this provides you a C Score and the report ID."

With new tech comes equal technological advancements for regulating said new sectors. Coinfirm's new branch of tools furthers the potential for AML on paper, although the resulting enforcement in practice could prove more difficult. After all, it would be up to individual projects to freeze transactions; an idea that remains controversial in an industry centered around the decentralized principles of Bitcoin — an arguably unstoppable global asset.