27/09/2023 Alexander

How to approach compliance and AML in DeFi and tokens

Pawel is joined by Andrew Kimbrough, Chief Compliance Officer of 1Inch Network to talk about the different ways in which compliance can be achieved in Decentralized Finance (DeFi) and crypto. Andrew explains that 1Inch Network is a DeFi aggregator rather than a tool for running liquidity pools or Automated Market Makers (AMM)s. According to Andrew, 1Inch Network is the best execution platform for trading in DeFi. 1Inch Network can also help break up big trades to get the best pricing while allowing access to various tokens which are not possible in centralized exchanges. 

Recently, 1Inch Network has also made the decision to move into the regulated space as DeFi is moving towards that direction. However, because the technology is ever evolving, 1Inch is still figuring out the methods in which this can be done so it is still a work in progress. 

Andrew believes that crypto has had a micro focus on Anti-Money Laundering (AML) for quite some time now whilst being under a self-regulatory organization’s umbrella but it doesn’t necessarily look at more general compliance aspects such as:

  1. market conduct
  2. conflicts of interest 
  3. corporate governance

He feels that these wider aspects of compliance regularly practiced in traditional finance are now beginning to reflect in the crypto industry. However, Andrew stresses that depending on jurisdiction and legislations in place, these may vary.


Compliance challenges in DeFi

Andrew mentions that although there is a merging of transaction monitoring and trade surveillance in the DeFi space, industry practitioners of crypto and blockchain are still struggling to comprehend:

  1. who controls the wallet
  2. Know-Your-Customer (KYC) 
  3. source of funds
  4. source of wealth 
  5. what customers want
  6. why they are trading with the company they are trading with 
  7. the pattern of trade which could help one determine their trading activity 

However, there is currently a movement towards overcoming these challenges.


The push to overcome DeFi’s compliance challenges

Pawel adds that DeFi and even Non-Fungible Token (NFT) players have initially said that they are not regulated by anyone and therefore they do not have to delve into compliance. So is this movement happening now because of government regulations or are people simply gaining more maturity about the regulatory approach?

Andrew says that there are three main reasons:

  1. customer demand and financial institution/ intermediary interest in DeFi
  2. people realizing that it is important for the crypto industry to move in that direction
  3. regulatory emphasis by many jurisdictions like the US where the regulators are becoming more sophisticated


Watch the whole discussion:


What steps can be taken to merge DeFi and traditional finance?

Andrew says that as well as determining risk buckets, the players of DeFi will need to get a horizontal view of the industry to see where the challenges will be and what actions should be taken to face those challenges efficiently.


Why does DeFi exist?

DeFi exists to provide a market for illiquid crypto assets like payment tokens or governance tokens because these tokens need a mechanism for exchange. DeFi can also cater to general liquid assets that do not trade enough to be economically feasible for a centralized exchange to hold. DeFi also acts as a holding platform for those who do not trade in large volumes but would like the ability to exchange tokens.


Is the DeFi technology safe enough to be deployed for larger transactions?

There have been hacks in the technology and tokens were stolen but they have robust resilience frameworks around this type of tech exposure.


Does decentralization really mean decentralization?

Andrew recalls an incident when his friend, an ex-prosecutor, said that behind all the exchanges made on a crypto platform, there is a person somewhere behind it. There is always somebody that one can go after and prosecute if something wrong is done, therefore pure decentralization doesn’t exist because there is always someone behind.


What are tokens really about?

The US Securities and Exchange Commission (SEC) has pushed crypto industry players to think about what tokens are really about. In jurisdictions like Switzerland, there is clarity and a clear definition of the tokens. They are either security tokens, payment tokens or utility tokens. Depending on these classifications, a law firm could advise an individual or a company as to whether or not they need to be licensed. 

However, in jurisdictions like the US, the SEC has recently announced that everything but Bitcoin is a security so they must stop trading as they are not broker dealers, licensed exchanges or a registered investment advisor.


Is Switzerland the best place to trade for crypto?

Switzerland is a very good jurisdiction for crypto in terms of the regulatory framework and being crypto friendly is their marketing pitch but the reality is that Switzerland is crypto tolerant. People can trade crypto in Switzerland or the EU provided that they remain within certain parameters. In addition, Switzerland has regulatory clarity and professional legal organizations who can give advice.