The U.S. Department of the Treasury has recently made a landmark proposal to establish a comprehensive anti-money laundering (AML) framework specifically for decentralized finance (DeFi) protocols using smart contracts. This initiative, launched on August 18, 2025, forms part of the Treasury’s broader efforts under the Guiding and Establishing National Innovation for US Stablecoins Act (GENIUS Act), which was signed into law in July 2025. The Treasury’s aim is to embed robust compliance mechanisms directly into DeFi platforms to prevent illicit finance activities such as money laundering, terrorist financing, and sanctions evasion, while shaping the regulatory future of this rapidly evolving sector.
Background and Regulatory Context
DeFi refers to virtual asset protocols and services that enable peer-to-peer financial transactions facilitated by self-executing smart contracts on blockchain technology. Despite DeFi’s promise of decentralization and financial innovation, the absence of traditional intermediaries has also made it vulnerable to exploitation by illicit actors—including cybercriminals, ransomware attackers, and hostile state actors like North Korea—who exploit weaknesses in AML and counter-terrorist financing (CTF) controls.
Recognizing this risk, the Treasury’s 2023 “Illicit Finance Risk Assessment of Decentralized Finance” was the first of its kind globally, identifying vulnerabilities stemming primarily from non-compliance by DeFi services with existing AML/CFT and sanctions obligations. The assessment concluded that effective regulation and compliance technology are essential to secure the integrity of the U.S. financial system without stifling innovation.
The Proposed AML Framework
The centric feature of the Treasury’s new proposal is the integration of digital identity verification tools embedded directly into DeFi smart contracts. These “wearable digital identifiers” or digital identity credentials—potentially including government-issued IDs, biometric data, and portable credentials—would act as real-time compliance gatekeepers. Before executing any transaction, a DeFi smart contract could automatically verify the user’s identity, effectively embedding Know Your Customer (KYC) and AML safeguards at the blockchain protocol level.
The proposal also emphasizes the use of artificial intelligence and blockchain analytics tools to enhance surveillance and detection capabilities. APIs linking these tools with DeFi platforms could allow for seamless monitoring and enforcement of compliance, reducing risks without creating excessive burdens for users or platforms.
Objectives and Goals
The Treasury’s initiative under the GENIUS Act aims to:
- Bring DeFi protocols under the regulatory umbrella similar to traditional financial institutions with respect to AML and CTF rules.
- Prevent criminals and sanctioned entities from exploiting DeFi services for illicit purposes.
- Reduce compliance costs by harnessing digital identity and AI technologies.
- Balance innovation with regulatory compliance in a sector marked by rapid technological change.
- Protect user privacy while ensuring transparency through verified digital identities.
Public Consultation and Stakeholder Engagement
The Treasury has opened a public consultation period on this proposal, which will remain active until October 17, 2025. Stakeholders including DeFi developers, financial institutions, regulators, privacy advocates, and the broader crypto community are invited to provide feedback. The Treasury intends to use insights from this consultative process to finalize the regulatory framework and draft potential new regulations.
Industry and Expert Reactions
The proposal has drawn mixed responses from different quarters. Traditional financial institutions and regulatory advocates applaud the move as a necessary step to close regulatory loopholes in the crypto financial ecosystem and bring transparency and accountability to DeFi transactions.
Conversely, some DeFi purists and decentralization advocates caution that embedding stringent identity verification within smart contracts risks undermining the foundational principles of DeFi, particularly user anonymity and censorship resistance. They warn that excessive regulation could stifle innovation and push DeFi activities to less regulated jurisdictions.
Future Implications
If adopted, the Treasury’s AML framework for DeFi would represent a paradigm shift in how decentralized finance is monitored and regulated. By making AML compliance an intrinsic part of the blockchain protocol, it could dramatically enhance efforts to combat illicit finance in crypto markets while fostering safer and more trustworthy decentralized ecosystems.
As blockchain and smart contract technologies evolve, the Treasury’s framework could also set a global precedent, influencing international approaches to regulating DeFi and digital asset services.
This development underscores the increasing recognition by regulators worldwide that decentralized finance, while innovative and transformative, necessitates novel regulatory approaches to mitigate risks without sacrificing its benefits. The outcome of the public consultation will be instrumental in shaping the future balance between innovation, privacy, and compliance in DeFi.
The support for integrating advanced technological solutions like digital IDs, artificial intelligence, and blockchain analytics indicates the U.S. Treasury’s commitment to leveraging innovation in enhancing financial security. The consultation period ending October 17, 2025, marks a critical juncture for stakeholders to influence the trajectory of DeFi regulation and the sector’s evolution.
The U.S. government’s next moves could include issuing further guidance, strengthening AML regulatory supervision for DeFi, and potentially introducing new legislative measures based on the consultation’s findings. This step signals a broader paradigm shift toward formalizing DeFi’s place within the regulated financial system while addressing long-standing challenges related to illicit finance in the crypto space.
AML Editor’s article was originally published in ainvest on Aug 18, 2025