DeFi laundering typologies encompass specific techniques where illicit actors integrate dirty money into DeFi platforms, layer it through complex transactions, and extract clean funds, often bypassing traditional KYC controls. Unlike centralized exchanges, DeFi operates via smart contracts on blockchains like Ethereum, enabling peer-to-peer lending, trading, and yield farming without intermediaries. Key characteristics include pseudonymity of wallet addresses, cross-chain transfers, and mixer integration, making traceability challenging for compliance teams.
Purpose and Regulatory Basis
DeFi laundering typologies serve as analytical tools in AML to map evolving threats, enabling risk-based due diligence and transaction monitoring tailored to virtual assets. They matter because DeFi’s rapid growth—handling billions in daily volume—amplifies ML/TF vulnerabilities, as seen in hacks like the $65 million DeFi exploit by a Canadian national using flash loans. The FATF provides the cornerstone via its 2021-2025 updates on virtual assets (VAs) and VASPs, mandating Travel Rule compliance and risk assessments for DeFi arrangements where control exists, even if decentralized.
In the US, the PATRIOT Act under Section 311 targets DeFi protocols as “high-risk” for mixers and privacy tools, requiring banks to sever ties, while FinCEN enforces BSA obligations on convertible virtual currencies. EU AMLDs (up to 6AMLD and AMLR 2024/1624) extend CASP registration, transaction screening, and FIU data-sharing to DeFi, with penalties up to 10% of turnover. These frameworks emphasize identifying “controllers” in DeFi DAOs to prevent regulatory evasion.
When and How it Applies
Institutions apply DeFi laundering typologies during onboarding, transaction monitoring, and investigations when handling VA transfers exceeding thresholds or showing DeFi wallet patterns. Triggers include high-velocity swaps on DEXs like Uniswap, liquidity pool manipulations, or inflows from sanctioned addresses. Real-world cases: Lazarus Group laundered $540 million from Axie Infinity via DEX conversions and Tornado Cash, employing “chain-hopping” across blockchains. Another: Hackers drain protocols via smart contract exploits, then layer funds through DeFi lending before cash-out.
Types or Variants
DeFi laundering typologies classify into several variants based on FATF and industry analyses:
- Chain-Hopping: Moving funds across blockchains (e.g., Ethereum to Binance Smart Chain) via bridges to evade tracking.
- DEX Swapping and Liquidity Pools: Rapid token exchanges on Uniswap or PancakeSwap to break audit trails, often with flash loans for amplified volume.
- Privacy Mixers/Enhancers: Using tools like Tornado Cash to pool and redistribute funds pseudonymously before DeFi reintegration.
- Yield Farming and Staking: Parking illicit funds in high-yield pools to legitimize gains, mimicking legitimate DeFi activity.
- DAO Governance Exploitation: Holding tokens to influence protocols for favorable laundering paths, though FATF clarifies this alone does not make one a VASP.
Procedures and Implementation
Financial institutions implement DeFi typologies through a risk-based AML program: (1) Map DeFi exposure via blockchain analytics tools like Chainalysis; (2) Screen wallets against sanctions/ILL lists; (3) Monitor for typology red flags using AI-driven rules (e.g., >$10K VA inflows from DEXs); (4) Embed controls in smart contracts for compliant DeFi projects. Ongoing processes include annual risk assessments, staff training, and VASP Travel Rule solutions for peer-to-peer VA transfers. Audits of DeFi integrations ensure no unmonitored exposures.
Impact on Customers/Clients
Customers face enhanced due diligence, such as wallet screening before DeFi-linked transfers, potentially delaying access to services. Restrictions include blocks on high-risk DeFi interactions, with rights to appeal via SAR processes or data access under GDPR/CCPA. Legitimate users may encounter “de-risking” if wallets touch risky protocols, pushing them toward compliant alternatives.
Duration, Review, and Resolution
Initial reviews trigger on transaction flags, lasting 24-72 hours for enhanced due diligence, with holds up to 10 business days under BSA. Periodic reviews occur quarterly for high-risk VA clients, annually for others, resolving via clear funds or SAR filing. Ongoing obligations mandate continuous monitoring, with resolutions documented for audit trails.
Reporting and Compliance Duties
Institutions must file SARs for suspected DeFi laundering within 30 days (US FinCEN) or immediately (EU FIUs), retaining records for 5-10 years. Documentation includes transaction graphs, risk scores, and rationale. Penalties: US fines up to $1M+ per violation; EU up to €10M or 10% turnover; personal liability for executives. Annual AML program certifications are required.
Related AML Terms
DeFi typologies interconnect with VASP registration, Travel Rule (FATF Rec. 16), mixer prohibitions (Section 311), and holistic screening combining on/off-chain data. They link to broader typologies like ATO or trade-based laundering when DeFi funds traditional fiat ramps.
Challenges and Best Practices
Challenges: Pseudonymity hinders attribution; cross-chain opacity; regulatory ambiguity for “unhosted” wallets. Best practices: Adopt blockchain forensics (e.g., Elliptic); collaborate via FIU.net; update smart contracts with AML logic; conduct scenario-based training. Risk-score DeFi protocols dynamically.
Recent Developments
2025 FATF updates strengthen RBA for VAs, urging SDD for low-risk DeFi while mandating VASP identification. US FinCEN eyes Section 311 on DeFi privacy tools; EU AMLR centralizes CASP supervision. Trends: AI monitoring rise; DAO compliance frameworks; North Korean hacks topping $1.7B laundered via DeFi.
DeFi laundering typologies are indispensable for safeguarding institutions against blockchain-enabled crime, ensuring compliance amid innovation.