FATF says most DeFi platforms have centralized control, calls for stronger supervision

Crypto Regulation News

The world's leading anti-money laundering agency points out that most decentralized finance (DeFi) platforms are not as leaderless as they claim. A report released on July 22 by the Financial Action Task Force (FATF) found that most platforms in the DeFi space still have actual decision-making power, and those holding these powers should be licensed and regulated like other financial practitioners. FATF standards are applicable in more than 200 jurisdictions around the world.

How FATF defines control in DeFi

This report divides DeFi into three different categories. The first category includes platforms with clearly identifiable controllers. The second category covers platforms that are actually centralized but the operators hide their identities. The third category is a small number of agreements that truly have no leader. The FATF rules apply to the first two categories, and only the third category is exempted.

report found that signs of centralized control emerged in multiple forms. Centralized governance tokens, management keys, the ability to upgrade protocol code, and core team management of the treasury all indicate that specific individuals have substantial power. Even running a front-end website that directs users to the protocol would be enough to make the individual a regulated subject under FATF standards. Developers, large token holders, front-end operators, and funders may all fall into this category.

For truly decentralized agreements, the FATF said regulators should focus on the ecosystem around them. Issuers of stablecoins that can freeze tokens, exchanges that handle legal currency entry and exit channels, and front-end operators are all regarded as touchable control points. The report states that if a platform completely refuses to cooperate, jurisdictions can use it as a last resort and ban it from operating within the country. Banks and exchanges are required to conduct due diligence on any DeFi platforms they work with or stop trading with them.

A near-comprehensive enforcement gap still exists

There is a huge gap between the FATF recommendations and actual implementation by countries. Nearly 93% of jurisdictions that responded to the FATF investigation have not yet applied the relevant standards to any eligible DeFi arrangement. Of the 142 countries surveyed, only 26 even assessed the risks posed by DeFi. Four countries have licensing rules in place, but only two countries have used these rules to register or license a platform.

FATF guidance is not binding law. Member states will be scored based on their level of compliance, and persistent gaps could lead to the country being placed on the organization's grey list. The July 22 report follows another update released by the FATF a few days ago, which found that most countries still have difficulty enforcing existing encryption rules at a fundamental level.

(Related article: DeFi losses exceed US$600 million in three weeks, Kelp DAO bridging vulnerability exploited)

The report uses North Korea as an example to illustrate the scale of the risks behind its recommendations. The FATF attributed two attacks in April to hackers linked to the North Korean state. The first was a $285 million vulnerability attack against Drift Protocol, a Solana (SOL)-based perpetual contract exchange, which took just 12 minutes to complete. The second was a $292 million hack of KelpDAO. Together, these two incidents account for approximately 76% of all cryptocurrency hacking losses so far this year.

The report shows that DeFi's total locked position value will reach US$86.6 billion this year, an increase of approximately 85% from 2023. The top 12 agreements account for more than 60% of the total. FATF Chairman Giles Thomson said the goal is to prevent criminals from taking advantage of new financial technologies while allowing legitimate innovation to continue to develop. He called for strengthened cooperation between the government and the private sector to enable law enforcement to be implemented on a large scale.