Metaverse Compliance Report (17): DeFi Money Laundering of Virtual Asset Crime

In last week’s public article, Sister Sa’s team introduced the field of virtual assets in detail and the latest trends in NFT money laundering crimes (see the article for details). Through a series of data, we can find that in 2022, when virtual currency anti-money laundering work has made excellent progress on a global scale, the pure use of Bitcoin, USDT and other coins is decreasing, and the behind-the-scenes players in the virtual world are trying to find new Criminal tools to replace or adapt traditional money laundering methods.

It turns out that NFTs and DeFi are quietly emerging as new tools for money laundering. At present, the illegal funds flowing to the NFT market and major trading platforms account for a small proportion but grow rapidly, with the characteristics of small amount, rapidity, and strong concealment. In contrast, criminals who use DeFi for money laundering are even more arrogant. At present, many government departments and blockchain data analysis companies have observed that a large number of illegal virtual assets are flowing into DeFi projects, which has raised concerns about the development prospects of decentralized financial projects. general concern.

What is DeFi?

I believe that partners who have been concerned about the development of blockchain technology and the currency circle for a long time must be familiar with DeFi. The full name of DeFi is Decentralised Finance . The Chinese name is “decentralized finance” or “decentralized finance”. In order to avoid ambiguity, this article uniformly calls it as DeFi.

Unlike most things in the world, DeFi does not have an exact birth time, or the idea of ​​blockchain technology + finance has been with Bitcoin since its birth in 2008. However, due to the limitations of Bitcoin’s script, it was not until Vitalik Buterin created Ethereum, which is more scalable and can build smart contracts, on the basis of Bitcoin in 2015 that DeFi really found the soil for taking root.

From the perspective of traditional finance, DeFi is an extremely small part of the huge financial system, and is contained in virtual assets and financial technology, but this small seed born in the blood of traditional finance contains subversion The power of the entire financial world. Many believe that DeFi represents the future of finance: HP Finance . Anyone with access to the network can use DeFi without barriers, including extremely poor areas or other groups without access to banking financial services.

Indeed, the ideal DeFi will bring many conveniences to users while ensuring the security of personal information, including lending funds to charge interest, obtaining loans for financing, purchasing overseas financial products, 24-hour open transactions, remittance without credit review, etc. , can truly realize the “individual has complete control” of HP Finance. In order to spread the beautiful blueprint of DeFi, Ethereum also made a comparison table between DeFi and traditional finance for users (see the figure below). But the reality is often very different from the ideal, and the beautiful original intention of DeFi cannot hide the twists and turns of its future.

Metaverse Compliance Report (17): DeFi Money Laundering of Virtual Asset Crime

Note: The form is from ethereum official website, URL:

If 2021 is a bull market for DeFi, early 2022 will be a bear market for DeFi. According to defipulse data, since the summer of DeFi (around May 2020) gave birth to top DeFi projects such as COMP token liquidity mining projects and Yearn Finance, which are still active so far, all key indicators of DeFi have been significantly improved. Improvement, the total locked funds even exceeded the $100 billion mark several times in 2021.

Metaverse Compliance Report (17): DeFi Money Laundering of Virtual Asset Crime

Note: The data comes from the defipulse official website, URL:

However, such popularity is not sustainable, and ups and downs are the norm in the market. As of the publication of this article, according to data from defipulse, the total locked funds in the DeFi market have fallen to $74.13 billion . In 90 days, since December 28, 2021 The overall performance has been underwhelming since the daily highs fell. At the same time, the limitations of DeFi itself are gradually entering the vision of regulators.

Metaverse Compliance Report (17): DeFi Money Laundering of Virtual Asset Crime

Note: The data comes from the defipulse official website, URL:

Recently, Caroline Crenshaw, an official of the United States Securities and Exchange Commission (hereinafter referred to as “SEC”), published an article on DeFi: “DeFi Risks, Regulations, And Opportunities” (DeFi Risks, Regulationgs, And Opportunities) As an SEC official, its The article expresses concerns about DeFi’s own shortcomings: Although DeFi provides more investment opportunities and financing channels, this unregulated market is affected by structural restrictions , mainly in: (1) lack of transparency in investment ; (2) The pseudonym system makes the market vulnerable to manipulation that is difficult to detect .

Metaverse Compliance Report (17): DeFi Money Laundering of Virtual Asset Crime

Note: The article is available on the SEC’s official website at

DeFi has gradually become an unfair market, and retail investors are often the first to be cut. In addition, there are loopholes in DeFi smart contracts that can be exploited by hackers, resulting in the theft of a large number of virtual currencies, the injection of stolen funds into some DeFi projects, and the gradual reduction of money laundering tools, etc. Problems have begun to attract widespread attention. It is imperative to try to regulate DeFi. Must do.

The current state of DeFi regulation

At present, there is no regulation for DeFi in China’s legal system, but according to the 9.24 notice, DeFi projects involving virtual currency are all illegal financial activities in China. In addition, the unauthorized sale of stocks, companies, corporate bonds or other financial products may violate my country’s “Banking Law”, “Trust Law”, “Securities Law”, “Fund Law” and other laws, as well as the “Regulations on the Administration of Futures Trading”. Administrative regulations and rules such as the Regulations on Preventing and Disposing of Illegal Fund-raising may even constitute a crime if the circumstances are serious. It can be said that DeFi projects are currently basically banned in my country. Similar to my country, the United States, which also adopts strong regulatory measures for virtual assets, is considering special legislation for DeFi.

Since the United States does not have a dedicated agency to supervise DeFi, it is currently regulated by multiple federal agencies, such as the U.S. Department of Justice, the Financial Crimes Enforcement Network Center, the Internal Revenue Service, the Commodity Futures Trading Commission and the Securities and Exchange Commission ( SEC), etc. Although many institutions jointly supervise DeFi, these regulatory measures have little effect at present. Compared with traditional finance, the investment risk of DeFi projects has not become smaller due to multi-sector supervision . The fundamental reason is that the current regulation of DeFi in the United States is incomplete. SEC official Caroline Crenshaw believes that investors participating in DeFi generally do not get the same compliance guarantees and strong information disclosure requirements as other regulated markets in the United States. For example, when the activities and assets of various DeFi participants involve securities and securities-related behaviors, although they are within the jurisdiction of the SEC, DeFi participants have not registered accordingly, making the SEC’s regulatory measures ineffective.

In terms of international regulation, in October 2021, the FATF (Financial Action Task Force Against Money Laundering) updated the “Updated Guidelines on Risk-Based Approaches to Virtual Assets and Virtual Asset Service Providers” (hereinafter referred to as the “Guidelines”) for DeFi A new definition has been made to define the providers of certain DeFi projects as virtual asset service providers (VASPs) under certain conditions. In terms of anti-money laundering obligations, these VASPs should meet the anti-money laundering standards of traditional financial companies and carry out the same strictness. KYC.

Metaverse Compliance Report (17): DeFi Money Laundering of Virtual Asset Crime

Although most people in the currency circle have always opposed the regulation of DeFi as a VASP, because many DeFi projects only help and facilitate the transfer of virtual assets between users’ personal wallets (through the underlying smart contracts to automatically execute the transfer between users’ wallets according to their own code) transactions), which do not directly hold the user’s funds. However, the FATF’s latest guidance still states that DeFi protocols can still be regulated as VASPs if they perform VASP-like functions, such as facilitating the exchange or transfer of virtual assets. Such DeFi project providers identified as VASPs should decide on specific regulatory measures based on “control or influence”, and when the DeFi project “actually has a person with control or sufficient influence , the jurisdiction should Define it using VASP and include it in the subject of anti-money laundering obligations”.

A First Look at DeFi Money Laundering

At present, according to the “2022 Crypto Crime Report Original data and research into cryptocurrency-based crime” (The 2022 Crypto Crime Report Original data and research into cryptocurrency-based crime) recently released by the authoritative blockchain data analysis consulting firm Chainalysis, The illicit funds received by DeFi projects throughout 2021 increased significantly compared to the previous year, accounting for 17% of all detected illicit funds (valued at approximately $1.46 billion), a figure that was only 2020. 2%, an increase of about 1900% year-on-year.

Metaverse Compliance Report (17): DeFi Money Laundering of Virtual Asset Crime

Metaverse Compliance Report (17): DeFi Money Laundering of Virtual Asset Crime

In contrast, centralized exchanges, which usually play a central role in traditional virtual asset money laundering and absorb the most illicit funds, absorbed about 47% of illicit funds in 2021, which did not increase much compared to the previous year. .

Stolen funds are pouring into DeFi like crazy

The explosive growth of DeFi in 2021 may be related to the large number of loopholes in the DeFi protocol, resulting in the frequent theft of various assets such as virtual currencies. The data shows that in 2021, fraud, darknet, and ransomware will play a stable role, while the share of stolen funds in total illicit funds will increase sharply. The value of stolen cryptocurrency for the full year was approximately $3.2 billion, an increase of 516% year-over-year from 2020. 72% of the stolen funds (about 2.2 billion) came from DeFi projects.

Metaverse Compliance Report (17): DeFi Money Laundering of Virtual Asset Crime

An interesting fact is that criminals who commit theft are more likely to use DeFi projects for money laundering after stealing the stolen money (through DeFi loopholes) (a philosophical sense of the original soup), while criminals who commit fraud are more likely to use DeFi projects for money laundering. It is more inclined to use old schol (old school) centralized exchanges for money laundering .

Metaverse Compliance Report (17): DeFi Money Laundering of Virtual Asset Crime

The main reason behind this is that the criminals who commit fraud are well-mannered and tactful, and are better at deceiving and deceiving but not good at computer technology, so they are more inclined to choose centralized exchanges with lower money laundering technical thresholds to launder money. Invading cryptocurrency platforms to steal virtual assets through computer system and DeFi protocol loopholes requires criminals to have professional computer technology and expertise. Facts have proved that although DeFi money laundering is hidden and efficient, it is safer and easier to use than centralized exchanges . The threshold is also higher .

In addition, it is worth mentioning that DeFi scams also need to be vigilant. It is precisely because of the prevailing structural barriers in DeFi projects that various scams are taking advantage of its anonymity and lack of transparency to make money wildly. Illicit funds obtained by criminals through DeFi scams increased by 82% in 2021, with a total of more than $7.8 billion in cryptocurrency or other virtual assets, of which more than $2.8 billion was stolen by a scam called “rug pulls” Gains (in the rug pulls scam, criminals often lure investors into funds by pretending to be authentic and credible investment projects, and finally run away with a bucket to cut the leeks ). The biggest rug pulls scam is the 21-year-old Thodex case. Thodex is a virtual currency exchange. After the exchange defrauded the victim of about $2.5 billion in cryptocurrency, the actual controller immediately ran away with the money and has not been caught yet.

Common methods of DeFi money laundering

To understand DeFi money laundering methods, you must first understand the basic operating rules of DeFi. Generally speaking, DeFi currently solves the pledge problem through cross-chain. Suppose now that we want to pledge BTC in exchange for ETH, the name of the cross-chain is called A chain, and the currency on the A chain is called A coin, then we need to do the following:

1. First lock the BTC we want to mortgage at an address in the A chain to generate an A-BTC representing this BTC token;

2. Then use the smart contract to mortgage the A-BTC on the A chain to generate the corresponding A coin;

3. Use A coin to buy other A-ETH;

4. Release A-ETH and convert it into ETH

At this point, we have successfully converted the BTC we held into ETH through cross-chain pledge. The whole process will be executed by the DeFi smart contract. If there is a default situation, the pledger’s BTC will be confiscated. This is the basic principle of DeFi cross-chain staking.

In May 2021, cyber hackers exploited a smart contract code flaw to steal around $30 million in crypto from a DeFi project called Spartan. The hacker then first converted most of these funds into X-ETH and X-BTC (that is, BTC or ETH tokens generated by any cross-chain) through cross-chain, and then used two or more special cross-chain transactions. DeFi projects, which transfer funds to the Ethereum blockchain for package conversion in exchange for new BTC and ETH. In the end, the hackers in this case sent the funds to a money laundering mixer called Tornado. Cashde to launder black money.

The process of DeFi money laundering does not seem to have many steps, but it is quite complicated to execute. Frequent cross-chain and fund jumps make anti-money laundering work more difficult . And because DeFi projects usually do not have strict KYC requirements, and they only promote the circulation of virtual assets without directly controlling user funds, DeFi has major flaws in identifying and freezing illegal funds, which is why DeFi projects are increasingly becoming money laundering tools.

write at the end

HP Finance is the original intention of DeFi. The ideal DeFi is indeed a good thing that can benefit the public and promote the development of the global economy. But in reality, DeFi’s many flaws are leading to frequent occurrences of virtual asset theft and fraud, seriously damaging DeFi’s reputation and investor confidence.

Sister Sa’s team believes that the anti-money laundering work of virtual assets will undergo new changes in 2022, and the overall will be professionalized, internationalized and digitalized. Major regulatory agencies not only need more professional talents, but also need to establish channels for effective communication with VASPs. In addition, international cooperation and cross-regional cooperation are also indispensable. The developed global network makes cybercrime more complex. It is difficult for a single country or region to solve all problems. Only sincere cooperation can we move forward together .

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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