Decentralized Finance (DeFi) promises financial services without traditional intermediaries – but this very decentralization creates thorny compliance challenges. Regulators worldwide are grappling with how anti-money laundering (AML), know-your-customer (KYC) rules and securities laws apply in a permissionless ecosystem.
Regulatory Landscape Across Jurisdictions
United States: Broad Enforcement of Existing Laws
Securities Regulation (SEC): U.S. regulators have signaled that “decentralization” is no defense against securities laws. The Securities and Exchange Commission (SEC) has applied the Howey test to tokens and DeFi activities, asserting jurisdiction if an investment of money in a common enterprise with an expectation of profits from others’ efforts is found.
In its first DeFi enforcement case in 2021, the SEC charged a DeFi lending project (Blockchain Credit Partners, d/b/a DeFi Money Market) for selling $30 million in unregistered securities via smart contracts. The project’s mTokens (which paid interest) and governance tokens (with profit-sharing rights) were deemed securities, and the SEC obtained a settlement and fines. This set a precedent that yield-bearing or governance tokens can fall under U.S. securities laws if they represent investment schemes.
The SEC has since ramped up scrutiny of major DeFi platforms. In April 2024, Uniswap Labs – developer of the largest decentralized exchange – received a Wells notice from the SEC, indicating planned enforcement action. The SEC’s focus was on Uniswap allegedly operating as an unregistered securities broker and exchange.
While the specifics are disputed, it’s clear the SEC views certain DeFi activities (like facilitating trading of tokens it considers securities) as subject to the same registration requirements as traditional venues. Other high-profile U.S. actions include the SEC’s 2023 lawsuits against centralized crypto platforms (e.g., Binance and Coinbase) which, although CeFi, underscore the SEC’s intent to label many tokens (some used in DeFi) as unregistered securities and exchanges as operating unlawfully. The extraterritorial reach of U.S. law means even overseas projects can be targeted if U.S. investors or markets are involved.
In 2023–2024, the SEC escalated its DeFi enforcement by settling actions against projects like Rari Capital and BarnBridge. Both involved yield-bearing or governance tokens the SEC deemed unregistered securities, resulting in fines and cease-and-desist orders.
Further, the SEC’s inclusion of various DeFi tokens in complaints against Binance and Coinbase suggests that major regulators consider many DeFi tokens to be securities. In July 2023, a court partially agreed with the SEC in the Ripple case, finding institutional sales of XRP violated securities laws (though programmatic exchange sales did not).
Additionally, the SEC has proposed broadening the definition of “exchange,” explicitly covering certain decentralized protocols that match trades. Although still pending, this rule indicates the agency wants to treat DeFi trading venues similarly to traditional broker-dealers, requiring registration if they list tokens deemed securities.
Commodity and Derivatives Regulation (CFTC): The Commodity Futures Trading Commission (CFTC) asserts jurisdiction over DeFi platforms offering derivatives or leverage. In a landmark 2022 action, the CFTC settled charges against the founders of bZeroX (a DeFi margin trading protocol) and then charged its successor Ooki DAO – an unincorporated decentralized autonomous organization – for operating an illegal leveraged trading platform and failing to comply with the Bank Secrecy Act. Notably, the CFTC alleged the DAO itself (and by implication its token holders) was a “person” liable for violations, treating the DAO as a general partnership. This stance signaled that merely decentralizing governance via a DAO will not shield a project from U.S. law.
In another recent action (September 2024), the CFTC fined Uniswap Labs $175,000 for allowing illegal leveraged commodity transactions on its protocol. The order found that certain tokens traded on Uniswap’s platform were essentially tokenized derivatives that should only be offered on a registered exchange. CFTC Enforcement Director Ian McGinley warned, “DeFi operators must be vigilant to ensure that transactions comply with the law.”
These cases underscore U.S. regulators’ “same risks, same rules” approach – if a DeFi platform enables activity that would require a license in traditional finance, regulators will apply the same requirement in DeFi.
Further 2023 enforcement actions highlight the CFTC’s readiness to penalize DeFi protocols offering swaps or futures without proper registration. In September 2023, the CFTC announced settlements with three DeFi operators – Opyn, ZeroEx (0x), and Deridex – for illegally offering derivatives or margin products without registering as a swap execution facility (SEF) or futures commission merchant (FCM). Each settled, paying civil penalties and agreeing to cease unlicensed activity.
AML/KYC (FinCEN and OFAC): Anti-money laundering rules in the U.S. are primarily enforced under the Bank Secrecy Act (BSA) via the Financial Crimes Enforcement Network (FinCEN). The U.S. approach is activity-based: if you facilitate value transfer or exchange as a business, you are likely a “money services business” with AML/KYC obligations.
FinCEN’s 2019 guidance clarified that developers or entities behind DApps (decentralized applications) may be considered money transmitters if they have sufficient involvement (e.g., providing front-ends, collecting fees). This means a DeFi project that is not fully decentralized could be required to register as an MSB and implement KYC customer identification and suspicious activity reporting, much like a centralized exchange. Indeed, in the bZeroX/Ooki enforcement, the CFTC explicitly cited failure to implement a Customer Identification Program under the BSA as a violation – effectively enforcing KYC requirements on a DeFi trading platform.
The U.S. Treasury’s stance on DeFi and illicit finance was detailed in a 2023 report, which found that illicit actors (like North Korean hackers) have laundered funds through DeFi protocols and that “actors take advantage of vulnerabilities in the domestic U.S. AML/CFT framework” via DeFi. The report recommended strengthening enforcement and closing gaps, foreshadowing potential future regulations or legislation specifically targeting DeFi AML compliance.
While FinCEN has not yet brought a specific enforcement action against a DeFi protocol solely for AML failures, it has warned that many DeFi services qualify as money transmitters. In 2023, the Treasury issued an Illicit Finance Risk Assessment for DeFi, underscoring that “decentralized” does not negate BSA obligations if real persons or entities operate or profit from the protocol. FinCEN has also ramped up focus on crypto mixers, proposing in October 2023 to label some as ‘primary money laundering concerns’ under Section 311 of the USA PATRIOT Act. This suggests a willingness to regulate or block DeFi services that enable anonymizing large sums, especially if used by sanctioned or criminal groups.
Sanctions (OFAC): In 2022, the Office of Foreign Assets Control (OFAC) took the unprecedented step of sanctioning Tornado Cash, an Ethereum-based mixer (privacy protocol), adding its smart contract addresses to the sanctions list for facilitating over $7 billion in laundering (including North Korean illicit funds). This effectively made it illegal for U.S. persons to interact with those smart contracts.
The move sparked debate about treating open-source code as an “entity,” and indeed a U.S. federal appeals court in late 2024 ruled that OFAC had exceeded its authority by sanctioning Tornado Cash’s immutable smart contracts, since software code itself is not “property” under the law.
The court’s decision limited OFAC’s reach over decentralized protocols, but the broader point stands: U.S. authorities are willing to use sanctions and law enforcement against DeFi tools that are seen to facilitate crime or evade AML controls. If no explicit crypto statute exists, traditional laws (securities, commodities, BSA/AML, sanctions) are being applied forcefully to DeFi activities.
Beyond Tornado Cash, OFAC has continued sanctioning crypto mixers used by North Korean hackers, such as Sinbad.io. This shows a pattern: if a DeFi-like tool is predominantly used for criminal laundering, OFAC may designate it. U.S. persons (and many global exchanges) then block transactions with those addresses. In the wake of Tornado Cash’s sanctions, some DeFi front-ends began blocking addresses flagged by blockchain analytics.
Judicial Rulings Affecting DeFi Compliance (In More Details)
DAO Liability – CFTC v. Ooki DAO (2023)
A federal court found that a DAO can be treated as an unincorporated association subject to U.S. law. By entering a default judgment, the court required the Ooki DAO to cease its illegal leveraged trading operations and pay penalties.
Tornado Cash Sanctions Appeal (5th Cir. 2024)
Risley v. Uniswap (S.D.N.Y. 2023)
SEC v. Ripple Labs (S.D.N.Y. 2023)
Implications for DeFi and Compliance Strategies
Securities Compliance
Founders must assume DeFi tokens or yield products can be classified as securities, especially if marketed as investments. Consider registering offerings or restricting U.S. investor access (e.g., via accredited-only sales) to avoid SEC action.
CFTC Oversight of Derivatives
AML/KYC Programs
Sanctions Risks
DAO Liability
Judicial Uncertainty
Strategic Entity Formation
European Union: Framework with Decentralization Carve-Outs
The European Union has moved toward comprehensive crypto regulation, though it distinguishes truly decentralized arrangements from those with intermediaries. Two pillars of EU policy affect DeFi compliance: the new Markets in Crypto-Assets (MiCA) regulation for crypto markets and existing/upcoming AML directives and regulations for financial crime prevention.
MiCA’s Scope and Application
Coverage of Centralized Crypto Services
The EU’s Markets in Crypto-Assets Regulation (MiCA) establishes a regulatory framework for crypto-asset issuers and service providers. It applies to any natural or legal person (or similar undertaking) engaged in crypto-asset activities – for example, operating trading platforms, facilitating exchanges, custody services, and so forth. In effect, centralized crypto services (such as exchanges, brokers, custodians, and other intermediaries) fall squarely under MiCA. These Crypto-Asset Service Providers (CASPs) must obtain authorization and comply with operational and prudential requirements, similar to traditional financial institutions.
MiCA enumerates various types of regulated crypto-asset services, including: custody and administration of crypto-assets for clients, operating a crypto-asset trading platform, exchanging crypto-assets for fiat or other crypto, execution of client orders, placing of crypto-assets, providing advice on crypto-assets, and related functions. Any intermediary performing these activities in the EU is in scope and will need a MiCA license (with associated governance, capital, and consumer-protection obligations).
Stablecoin Issuers
MiCA devotes special provisions to stablecoins, referred to as Asset-Referenced Tokens (ARTs) (stablecoins referencing multiple assets or non-fiat values) and E-Money Tokens (EMTs) (stablecoins referencing a single fiat currency). Issuers of such tokens must be legally incorporated in the EU and obtain authorization from a national regulator to issue them. Key obligations for stablecoin issuers include maintaining sufficient reserve assets, publishing a detailed white paper, offering redemption rights at par for holders, and adhering to prudential safeguards to protect monetary stability. Significant stablecoins (with large user bases or transaction volumes) face even tighter supervision, potentially including limits on daily transaction volume.
Crypto Trading Platforms
MiCA explicitly covers crypto trading venues. Any entity operating a platform that brings together buyers and sellers of crypto-assets (whether for crypto-to-crypto or crypto-to-fiat trades) is considered a CASP and must be authorized. Such platforms must meet ongoing compliance duties: maintaining minimum capital, ensuring managers are fit and proper, implementing cybersecurity controls, segregating client assets, and providing transparent operations.
Carve-Out for Decentralized Services (Recital 22)
While MiCA casts a wide net over centralized actors, it pointedly exempts fully decentralized activities. Recital 22 clarifies that if crypto-asset services are provided in a “fully decentralised manner” without any intermediary, they should not fall within the scope of the regulation. Thus, if a service truly runs autonomously on a decentralized network with no controlling party, EU lawmakers did not intend to capture it. However, this exemption is noted in a recital rather than detailed operative articles, leaving room for interpretation. Regulators emphasize that partial or hybrid decentralization (where an identifiable party retains some control) likely does not qualify for the carve-out. In essence, MiCA’s coverage extends to any service where a person or entity performs an intermediary function.
DeFi Projects with Some Central Control
A key question is how MiCA classifies DeFi projects that are not fully decentralized. MiCA’s wording suggests that any form of central “intermediation” brings a project within scope. If a DeFi arrangement involves a team operating a front-end, collecting protocol fees, or otherwise controlling upgrades, that team could be deemed a CASP. Officials have signaled that true decentralization must mean the absence of a controlling entity. If a DeFi project is partially decentralized (“HyFi,” or hybrid finance), MiCA will likely apply. Many current DeFi protocols have facets of centralization—admin keys, core dev teams, or small governance groups—which, from a regulatory standpoint, may trigger full compliance obligations under MiCA.
Impact of MiCA on DeFi
Defining “Fully Decentralized” – EU Perspective
MiCA does not define “fully decentralized,” leaving a significant gray area. European regulators generally consider whether a project has no entity exercising control, no governance token concentration, no fee collection by a specific party, and no centralized front-end with gatekeeping powers. Only if every aspect is automated and dispersed, with no single group in charge, would it likely be exempt. Because that threshold is high, most DeFi projects risk classification as CASPs if they retain any managerial or economic control.
Which DeFi Aspects Might Still Fall Under MiCA
Even if the protocol itself is autonomous, various aspects can bring it under MiCA:
Governance Token Issuance: A team offering governance tokens to EU users may need to comply with token issuance rules under MiCA, including drafting a compliant white paper.
Liquidity Pools & Protocol Operations: If a DeFi developer or entity retains an admin key or collects fees, regulators could treat them as a crypto-asset service provider.
Treasury Management: Fees that accrue to a foundation or multisig group could be viewed as service revenue, suggesting there is an identifiable operator or beneficiary.
Protocol Governance: If governance token holders can upgrade or change the protocol, the system may not be fully autonomous, exposing key holders to regulatory obligations.
Obligation for DeFi Protocols to Comply
If a project maintains operations in the EU but does not meet the “fully decentralized” standard, it may be forced to obtain a CASP license under MiCA. That entails duties akin to those imposed on centralized exchanges, such as governance, disclosures, capital, and consumer protection. Projects may evolve into hybrid models—where the underlying smart contract is open, but the front-end or development team is regulated. Others may prefer to geofence EU users or further decentralize operations to avoid regulation.
EU AMLD6, DORA, and AML Regulations
Application of AMLD6 to Crypto Services: The EU’s Sixth Anti-Money Laundering Directive (AMLD6), part of a broader AML legislative package, expands the scope of “obliged entities” to include crypto-asset service providers (CASPs) across the EU. This means centralized crypto businesses (exchanges, custodial wallet providers, brokers, etc.) are explicitly subject to AML/CFT requirements akin to those for traditional financial institutions.
Under AMLD6 and the accompanying EU AML Regulation, CASPs must implement customer due diligence, monitor transactions, keep records, and report suspicious activity. Newly adopted EU rules also require CASPs to collect and store information on the source and beneficiary for each crypto transaction, effectively implementing the “travel rule.”
Application of DORA to Crypto Businesses: The Digital Operational Resilience Act (DORA) is a separate EU regulation focusing on cybersecurity and operational continuity for financial entities, including CASPs authorized under MiCA. As of January 2025, centralized crypto businesses must have robust security controls, incident reporting mechanisms, business continuity plans, and undergo operational resilience testing. In essence, bank-grade resilience standards will apply to crypto firms, aiming to reduce hacks and service outages in the digital asset space.
DeFi Projects as VASPs – Classification Challenges: Under global standards (FATF) and EU definitions, simply labeling a platform as “DeFi” does not exempt it from regulation. If individuals or entities exercise control or significant influence over a DeFi arrangement, they may be treated as virtual asset service providers (VASPs) with AML obligations. A DeFi project featuring an identifiable company collecting fees or operating a front-end will likely be deemed a crypto-asset service provider. On the other hand, a fully decentralized protocol with no controlling party is in a gray area; however, authorities are inclined to apply a “substance over form” test, meaning a DeFi platform with centralized elements can be compelled to comply with AML/KYC requirements.
Obligations for DeFi Lending, DEXs, and Custodial Services: If a DeFi platform is deemed an obliged entity, it faces obligations similar to centralized providers. For lending protocols, this could mean enforcing KYC on users supplying or borrowing assets if there is an identifiable operator. Decentralized exchanges (DEXs) that match trades or collect fees may be treated as VASPs, thus required to identify users and report suspicious transactions. Custodial services are straightforwardly in scope—anyone holding crypto on behalf of others has been subject to AML laws since AMLD5 and continues to be under AMLD6. Even non-custodial DeFi projects that interact with EU customers could face indirect obligations if there is an identifiable entity offering the service.
Implementation Status & Timeline of Key EU Measures
AMLD6 (Sixth Anti-Money Laundering Directive)
AMLD6 was adopted as part of the 2024 AML package and entered into force in July 2024. As a Directive, it must be transposed into national law by EU Member States, with a final deadline of mid-2027 for full implementation. While many AML obligations already apply to crypto service providers under prior directives, AMLD6 introduces more stringent mechanisms and penalties.
EU AML Regulation (AMLR) – the “Single Rulebook”
EU Anti-Money Laundering Authority (AMLA)
Digital Operational Resilience Act (DORA)
Transfer of Funds Regulation (Crypto Travel Rule)
Pending Proposals and 2024+ Outlook
Comparative Analysis
EU vs. U.S.
The EU is moving toward a unified AML framework enforced by AMLA, whereas the U.S. relies on FinCEN regulations (BSA) and multiple enforcement agencies. While both treat crypto exchanges as obliged entities, the U.S. often communicates compliance expectations via enforcement actions, and has taken high-profile measures against mixers and exchanges. The EU’s single rulebook aims for more preventive supervision, though it can also impose large fines and coordinate criminal prosecutions via Member State authorities.
EU vs. UK
EU vs. Singapore
EU vs. Switzerland
Regulatory Obligations & Risks for DeFi Projects
Smart Contract-Based Services Under AML Rules: If a DeFi service qualifies as exchange, transfer, or custody under EU law, and there is an entity or persons behind it, AMLD6 and related regulations can apply. Authorities will hold operators or developers accountable if they exercise control, even if transactions occur via automated smart contracts. The law targets the persons or entities benefiting from or running the platform, rather than the code itself.
Enforcement on Decentralized Protocols: Truly decentralized protocols pose challenges for regulators, but enforcement can focus on:
Individuals/Entities: Developers, founders, or DAOs who maintain or profit from the system.
On/Off-Ramps: EU-regulated exchanges can reject or scrutinize funds from non-compliant DeFi sources.
Technical Measures: Authorities may require front-ends to implement geolocation blocks, address screening, or adopt zero-knowledge-based KYC solutions.
Legal Risks for DeFi Founders and DAOs: Those found knowingly facilitating money laundering or ignoring AML obligations could face fines or criminal liability. AMLD6 broadens the definition of offenses and strengthens information sharing among Member States, boosting cross-border investigations. DAOs might be treated as unincorporated associations whose active participants can be liable.
Will DeFi Have to Implement KYC/AML? If DeFi wants mainstream adoption and integration with regulated finance, it may need optional or mandatory compliance layers—e.g., whitelisted pools or KYC gates. Over time, regulatory pressure from authorities and off-ramps will likely push more DeFi protocols to adopt or at least accommodate AML measures.
Interaction with the Travel Rule & Unhosted Wallet Rules
EU Travel Rule Extension to Crypto: Starting December 2024, all crypto transfers involving a CASP must include identifying information on the originator and beneficiary, mirroring traditional wire transfer rules. CASPs must refuse or halt transfers lacking complete data. No de minimis threshold exists—any transfer, regardless of amount, requires this information.
Treatment of Unhosted Wallets: Unhosted wallets (self-custody) complicate the travel rule because there is no second institution to receive data. EU CASPs must still record and verify user information for unhosted wallets above certain thresholds. In practice, this may mean proving ownership of the receiving address. Smart contract addresses used in DeFi (e.g., liquidity pools, DAOs) also count as “unhosted,” prompting some CASPs to demand enhanced due diligence or refuse direct transfers.
Impact on DeFi Liquidity Providers and DAOs: Liquidity providers withdrawing from an EU exchange to a DeFi pool might need to route funds to their own verified wallet first or prove ownership if exceeding €1,000. Deposits from privacy-enhancing protocols can be flagged as high risk. DAOs operating treasuries could face challenges off-ramping to fiat if no single verified individual claims the wallet. Exchanges, under pressure to comply, may reject or closely scrutinize funds from unknown DeFi addresses.
Privacy and GDPR Considerations: An interesting twist in the EU is the General Data Protection Regulation (GDPR), which imposes rules on handling personal data. KYC data (names, IDs, etc.) is obviously personal data that must be stored securely and minimized. A conflict arises if one tried to record compliance information on an immutable blockchain. Once on-chain, data cannot be erased, clashing with GDPR’s “right to be forgotten.”
Most DeFi projects avoid putting any personal data on-chain (favoring off-chain or zero-knowledge proofs), but as regulators push for on-chain identity attestation or allow verified credentials, projects must design systems that reconcile transparency with privacy law. Moreover, any DeFi company handling EU resident data needs GDPR compliance (privacy notices, breach protocols, etc.), adding another layer of regulatory complexity beyond financial laws.
Asia
Singapore
Singapore has sought to be a crypto-friendly hub while enforcing strict AML standards. Under the Payment Services Act 2019 (PSA), any business providing digital payment token services (e.g. crypto trading, transfer, or custody services) must be licensed by the Monetary Authority of Singapore (MAS). This licensing comes with AML/CFT requirements – Singapore mandates full KYC for regulated crypto services, transaction monitoring, and compliance with FATF travel rule requirements.
DeFi protocols per se are not explicitly carved out under the PSA; however, MAS has generally taken a “same activity, same regulation” stance. If a Singapore-based team runs a crypto lending or trading platform (even if using DeFi tech), regulators would likely view it as a financial service that needs either a license or an exemption via a sandbox.
In practice, Singapore has encouraged experimentation through initiatives like Project Guardian, where regulated financial institutions explore DeFi for tokenized assets in a controlled environment. MAS officials have acknowledged the reality of DeFi and discussed potentially new frameworks – for instance, MAS’s chief fintech officer has suggested that entirely avoiding identification in DeFi is “not realistic” in the long run. Startups in Singapore thus often create two layers: an open-source protocol (which MAS might not regulate directly if truly decentralized) and a front-end company that interfaces with users (which would need a license and KYC).
Notably, Singapore has also restricted marketing of crypto to the public and discouraged risky retail speculation, which means DeFi projects targeting Singaporean users should be cautious in how they advertise and ensure they are not offering prohibited products (like derivatives) without proper authorization.
Hong Kong
Hong Kong pivoted to embrace crypto under a new regulatory regime, allowing retail trading of approved cryptocurrencies on licensed exchanges as of 2023.
The Securities and Futures Commission (SFC) in Hong Kong has made it clear that DeFi projects are not above the law. If a DeFi activity falls under existing definitions of regulated activity – e.g., operating an exchange, offering securities, or managing assets – it will require the appropriate SFC license. Providing automated trading services, even in a decentralized platform, triggers licensing (Type 7 ATS license) if the assets traded are “securities” or futures by Hong Kong’s definition. Likewise, offering what amounts to a collective investment scheme (like a yield farming pool inviting Hong Kong public investment) would require authorization.
Hong Kong regulators see DeFi through the lens of risk: concerns include financial stability, lack of transparency, market manipulation (e.g. oracle attacks, front-running) and investor protection. They have indicated that operators and developers can be held accountable if they are in Hong Kong or target Hong Kong investors.
Thus a DeFi startup in Hong Kong might need to either geo-fence Hong Kong users or ensure full compliance (including KYC and investor eligibility checks) for any product that might be deemed a security or trading facility.
Japan
Japan was one of the first major jurisdictions with a clear regulatory regime for cryptocurrency, and it continues to enforce one of the strictest AML/KYC standards. All crypto exchanges in Japan must register with the Financial Services Agency (FSA) and implement KYC for all customers.
While Japan has not issued specific DeFi regulations, any service that custodies assets or intermediates trades would likely fall under existing laws (the Payment Services Act for crypto exchange or funds transfer, and the Financial Instruments and Exchange Act if it involves securities/derivatives). For example, a DeFi protocol enabling margin trading or synthetic stocks would likely be seen as offering derivatives to Japanese residents, which is unlawful without a license.
Japan implements the FATF Travel Rule through the Japan Virtual Currency Exchange Association – meaning exchanges must collect counterparty information for transactions. If DeFi usage makes it hard to trace such information, Japanese regulators may respond by limiting exchange interactions with DeFi platforms that don’t meet compliance standards.
Culturally, Japan emphasizes consumer protection (they infamously have a whitelist for tokens that exchanges can list). A completely permissionless DeFi application sits uneasily with that ethos. Thus, while one won’t find an “FSA DeFi rulebook,” a Japan-based founder should assume that if their protocol becomes popular in Japan, authorities might demand a compliance interface or even pressure to block Japanese IPs if the product can’t be monitored for AML.
Other financial centers in Asia are also shaping DeFi oversight. South Korea treats crypto exchanges strictly (real-name verified accounts only, strict AML). After incidents like the Terra-Luna collapse, Korean regulators grew even more vigilant about crypto schemes. A DeFi project involving Korean users could be seen as an unregistered securities offering (if promising yields) or simply an illegal investment program if not approved. China remains effectively closed to cryptocurrency trading (outright ban), focusing on its central bank digital currency and permissioned blockchain tech. India has taken a tough stance with heavy taxation on crypto transactions, sometimes discussing an outright ban – a hostile environment for DeFi compliance. Meanwhile, Thailand and Malaysia have licensing for digital asset businesses that might ensnare certain DeFi activities. Overall, Asia presents a mix of innovation sandboxes and strict rules; the common theme is that if a DeFi project has an identifiable presence or target market in a jurisdiction, local regulators will apply existing financial laws.
Other Jurisdictions
Switzerland: Long seen as a crypto-friendly jurisdiction, Switzerland (through regulator FINMA) applies a technologically neutral approach to DeFi. FINMA has explicitly stated that it applies existing rules to DeFi applications under the principles of technology neutrality and “same risks, same rules,” looking past form to substance. If a DeFi application in Switzerland offers a service equivalent to banking, trading, or asset management, FINMA will require the appropriate license just as it would for a traditional provider. For example, running a decentralized exchange in Switzerland could trigger the need to be an authorized securities dealer or exchange if there is a central coordinating entity.
Switzerland is notable for its AML rules regarding crypto: FINMA regulations (as of 2021) lowered the threshold for anonymous crypto transactions to CHF 1000, meaning Swiss VASPs must KYC customers even for relatively small amounts. This was done to close a loophole and prevent structuring of transactions to avoid AML checks.
In a DeFi context, while Swiss law can’t force an on-chain DEX to conduct KYC, any Swiss-regulated intermediary (like a crypto bank or broker) interacting with DeFi liquidity must ensure no anonymous large transfers occur.
Swiss authorities have also pioneered solutions like OpenVASP (a protocol for Travel Rule data exchange) to facilitate compliance even in decentralized transfers. Moreover, many DeFi projects have used the Swiss nonprofit foundation model to launch (to issue tokens under guidance from FINMA’s ICO framework). While this can be effective for token classification (utility vs asset tokens), the foundation must still implement AML controls if it engages in any custodial or exchange-like activities.
United Arab Emirates: The UAE, particularly Dubai and Abu Dhabi, has set up regulatory regimes to attract crypto businesses. Dubai’s new Virtual Assets Regulatory Authority (VARA) issues licenses for various crypto activities in the emirate (and some free zones), with an emphasis on meeting FATF standards – meaning KYC/AML programs are mandatory for licensees. Abu Dhabi’s financial free zone (ADGM) has a framework treating crypto exchanges and custodians on par with financial institutions, requiring customer due diligence and monitoring. Even as the UAE markets itself as a crypto hub, it demands compliance measures from those who set up shop. A DeFi exchange or yield platform based in Dubai would need to register with VARA under the appropriate category and implement KYC for users, transaction monitoring, and sanctions screening. The UAE is interesting because it explicitly allows what some other places don’t (like crypto token fundraising) but under oversight. DeFi founders often incorporate entities in the UAE to benefit from clear rules and 0% tax, but they should expect close interaction with regulators and ongoing audits to ensure no illicit finance is flowing. On the flip side, purely decentralized operations with no UAE entity fall outside these regimes – but then cannot easily use the UAE’s traditional banking or legal system.
Latin America: In Latin America, regulation ranges from nascent to non-existent, though the trend is toward more oversight. Brazil passed a law (effective 2023) requiring crypto service providers to register with the central bank and comply with AML/CFT measures. Mexico’s Fintech Law and subsequent rules require exchanges to register with the central bank and impose KYC – again focusing on centralized players. Many Latin American countries are still developing regulatory approaches; in places with capital controls or inflation, DeFi usage is high as an alternative, which raises political and AML concerns. Authorities might see DeFi as a channel to bypass currency rules or launder narcotics money, increasing the likelihood of future clampdowns. Enforcement can be uneven, but as global standards trickle down, regulators in the region are expected to tighten controls on DeFi. El Salvador adopted Bitcoin as legal tender and has been encouraging crypto businesses – but it also must follow FATF standards, meaning AML obligations still apply.
Global Standards (FATF): Overarching all these jurisdictions is the influence of the Financial Action Task Force (FATF), which sets AML/CFT standards followed by 200+ countries. FATF extended its standards to “virtual asset service providers” in 2019, which countries are implementing in various ways. FATF has explicitly highlighted DeFi as a potential gap: in a 2023 update, it noted that conducting comprehensive DeFi risk assessments is challenging for most jurisdictions due to data and enforcement difficulties. FATF recommends that if a DeFi arrangement has “owners or operators,” countries should hold those parties accountable as VASPs even if the system brands itself decentralized. Conversely, if truly no person exercises control, some activity might fall outside conventional regulation. The Travel Rule applies to crypto transfers over a threshold, meaning as countries enforce this, DeFi protocols that interface with regulated entities will feel indirect pressure to facilitate the required information sharing or risk being geofenced.
Decentralization vs. Regulatory Requirements
The core paradox is that DeFi is designed to eliminate centralized control, yet laws are enforced by finding someone – a person or entity – to hold responsible. Traditional compliance frameworks assume a regulated entity (a bank, exchange, broker) can perform KYC checks, maintain records, and be examined or sanctioned for failures. DeFi breaks this model by enabling peer-to-peer interactions governed by smart contracts. If no one controls a protocol, who is responsible for ensuring compliance?
Regulators are increasingly taking the view that most DeFi projects aren’t as decentralized as they claim. Truly decentralized projects present a dilemma: regulators either have to regulate the users themselves or impose rules at the periphery (e.g., on interfaces or on-off ramps). This conflict can put founders in an untenable position. If they fully decentralize (renounce control, launch code and step away), they might avoid being a regulated entity – but then they also relinquish the ability to adapt the protocol to comply with future rules. If they retain control to enforce compliance (like adding KYC gating), they defeat the core premise of open, permissionless access. Walking this tightrope is perhaps the fundamental challenge of DeFi compliance.
Enforcing AML/KYC in Permissionless Systems
AML and KYC rules require identifying customers, monitoring transactions, and reporting suspicious activity – tasks that assume a gatekeeper is present. In DeFi protocols, users connect wallets and transact with no onboarding process collecting names or IDs. Smart contracts do not discern good versus bad actors; anyone with a wallet and assets can participate. This permissionless design is superb for accessibility and innovation, but it’s a nightmare for AML enforcement. Authorities worry that criminals, sanctioned nations, or terrorists can freely move funds through DeFi protocols to obscure their origin.
Enforcing KYC in this environment has proven difficult. A DeFi platform can’t easily compel every user globally to upload an ID – there is no customer account creation step in most DApps. Some projects have tried to implement opt-in KYC or whitelisting: for instance, creating “permissioned pools” where only verified addresses can participate. Others have introduced blocklists on front-ends, preventing known illicit addresses from interacting through the official website.
Regulators increasingly rely on ex post enforcement and chain analytics to trace illicit funds and identify suspects. DeFi founders can mitigate risk by integrating blockchain monitoring tools that flag suspicious flows, cooperating with law enforcement when required, and avoiding explicit facilitation of money laundering.
Smart Contracts, Anonymity, and Illicit Finance
DeFi’s infrastructure offers both transparency (every transaction is public) and anonymity (user addresses are pseudonymous). This combination creates opportunity and risk. It enables open financial innovation but also invites exploitation by criminals. Bad actors can chain-hop across multiple DeFi protocols, use privacy mixers, and rapidly launder stolen funds. Sanctions evasion becomes easier if no on-ramp checks identity. Fraud and market manipulation (rug pulls, pump-and-dumps, oracle exploits) are common in a space lacking centralized oversight.
DeFi founders thus face mounting pressure to proactively mitigate illicit finance risks. Without a compliance framework, entire protocols can be blacklisted or sanctioned, as the Tornado Cash saga illustrated. Self-regulation through code audits, risk monitoring, KYC gating, or blocklists may become the norm if DeFi wants to operate within the confines of global law. Projects that remain staunchly permissionless risk isolation from regulated finance, as banks and centralized exchanges refuse to interact with them due to compliance concerns.
Securities Regulations in DeFi
If a token is deemed a security in a certain jurisdiction (like the U.S.), offering it or facilitating trades could require registration, disclosures, and licenses. DeFi blurs lines because tokens serve multiple roles (governance, utility, investment instrument). Regulators have grown skeptical of superficial decentralization arguments, emphasizing that governance tokens conferring profits or yields are likely securities. Yield farming and liquidity mining may likewise be treated as investment contracts if participants expect profit from a team’s efforts. Some DeFi projects try to exclude U.S. IPs, use disclaimers, or adopt progressive decentralization to reduce securities risk. Yet enforcement actions indicate that disclaimers alone won’t suffice. Projects must carefully structure tokenomics and marketing to avoid crossing into regulated territory.
Extraterritorial Impact of Major Regulations
A daunting aspect for global DeFi startups is that the laws of the U.S. (and, to a lesser extent, the EU) can reach far beyond their borders. U.S. regulators have not hesitated to prosecute foreign projects that serve American users, claiming jurisdiction whenever U.S. investors or markets are involved. Likewise, the EU’s regulations can affect anyone offering services to EU citizens. This extraterritorial reach means that even if a DeFi project is based in a crypto-friendly jurisdiction, it could still face scrutiny from major regulators. The risk of enforcement may lead projects to geo-block certain regions, incorporate offshore, or become genuinely decentralized so no entity can be targeted. Nonetheless, as DeFi grows, regulators are forging cross-border coalitions to prevent regulatory arbitrage. Founders cannot ignore the biggest markets if they want mainstream adoption. Jurisdictional choices thus require careful planning, balancing legal exposure with business strategy.
Guidance for DeFi Founders & Startups
Balance Decentralization with Compliance from Day One
Decide early which aspects of your project will be decentralized vs. controlled, and plan compliance measures accordingly.
Incorporate a legal entity for the interface or development company if you anticipate regulatory scrutiny.
Document a roadmap to progressive decentralization, but maintain compliance for any centralized functions until fully decentralized.
Implement “Smart” AML/KYC Measures That Align with DeFi Ethos
Use tiered access or feature gating: allow basic permissionless usage for small amounts but require verification for large-volume activities.
Leverage decentralized identity solutions or zero-knowledge proofs to balance privacy with compliance.
Integrate real-time risk monitoring tools (e.g., blockchain analytics) to flag suspicious addresses.
Maintain off-chain documentation or audit trails to show good faith if investigated.
Navigate Securities Law Proactively
Avoid marketing tokens with explicit profit-sharing or investment-like features. Focus on utility and governance.
Use regulatory compliant fundraising (e.g., Reg D or Reg S offerings) if you sell tokens to raise capital.
Conduct ongoing legal reviews as token features evolve, documenting how you minimize securities risk.
Engage Regulators, Auditors, and Advisors Early
Join regulatory sandboxes or innovation hubs where possible to get feedback on compliant DeFi models.
Undergo third-party audits (technical security and legal compliance) and keep the reports to show regulators.
Stay in dialogue with compliance experts who can update you on shifting regulations.
Smart Jurisdiction Choices and Legal Arbitrage
Incorporate in crypto-friendly jurisdictions (e.g., Switzerland, Singapore, UAE) that offer clear frameworks.
Create separate entities for different functions (protocol foundation vs. operating company) to compartmentalize risk.
Remain flexible: regulations can shift, so be ready to relocate or restructure if your chosen haven becomes hostile.
The regulatory environment is moving fast, and every crypto or DeFi project deserves a clear strategy for staying ahead. Whether you’re determining if your platform qualifies for carve-outs or planning a compliant token sale, the right legal guidance can make all the difference.
At Prokopiev Law, we blend practical crypto experience with deep legal insight to help you:
Pinpoint where your project stands under applicable laws—and whether you can leverage its DeFi exemptions
Structure your operations, from entity setup to licensing routes, to safeguard your vision
Create and review essential documentation for token offerings, stablecoin issuance, and more
Stay informed and compliant as the EU’s regulatory framework continues to evolve
Your innovation deserves the strongest legal foundation. Reach out to Prokopiev Law today to learn how we can protect your ambitions and pave the way for long-term success.
The information provided is not legal, tax, investment, or accounting advice and should not be used as such. It is for discussion purposes only. Seek guidance from your own legal counsel and advisors on any matters. The views presented are those of the author and not any other individual or organization. Some parts of the text may be automatically generated. The author of this material makes no guarantees or warranties about the accuracy or completeness of the information.
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