Financial crime in the decentralized finance ecosystem: new challenges for compliance

Published date03 November 2021
Date03 November 2021
Subject MatterAccounting & finance,Financial risk/company failure,Financial crime
AuthorChristoph Wronka
Financial crime in the
decentralized nance ecosystem:
new challenges for compliance
Christoph Wronka
Deloitte GmbH Wirtschaftsprufungsgesellschaft, Hamburg, Germany
Purpose As decentralized nance (DeFi) has collected substantial promotion, investment and
cryptographic developmentas a new model for numerous nancial operations over the last months. As DeFi
models and technology are quite unique,authorities have not been engaged much yet. However, these non-
regulated nancial markets willbe overlooked for no long by the regulators. Therefore, the purpose of this
paper is to analyse and evaluate the new challengesfor nancial crime compliance which need to be tackled
very soon.
Design/methodology/approach The research relied on secondary sources of data, using secondary
research to collect archival data in the form of documents. Content and thematic analyses were used to
synthesizethe collected data
Findings DeFi is considered to be one of the majorsteps towards adopting crypto masses. It is expected
that DeFi will play a signicant role in future and provide the present banking system with a feasible
alternative. Therefore,it is crucial that the DeFi industry mustaddress the main risks to ensure its userfull
Originality/value This research is the rst to analyse the emerging challenges of ghting nancial
crime in the DeFi ecosystem.
Keywords Compliance, Financial crime, Monetary systems, Decentralized nance, DeFi
Paper type Research paper
1. Introduction
1.1 Background
Decentralized nance (DeFi) is increasing rapidly as an alternative to traditional nancial
services that is safer, transparent and more effective. By removing the need for centralized
nancial institutions, we build a more open and reliable nancial system. DeFi, secured by
blockchain technology, will decrease the danger of fraud, corruption and asset maladministration.
It will also make nancing management much cheaper and efcient, without overdraft charges, no
cable transfers and banking hours to verify a transaction. The term DeFi is a nancial
system without the requirement of traditional, centralized intermediaries. It is all used to a
Bank and other nancial institutions, such as a worldwide exchange, but DeFi provides a
system that can work independently (Zhang et al., 2018). Maybe the best-recognized use of
DeFi is online transactions using DeFi cryptocurrency. Still, DeFi allows us to deal more
effectively and transparently with various nancial applications such as investment,
insurance, exchange, borrowing and lending.
1.2 Basic and methods of decentralized nance
DeFi uses technology rather than a bank that facilitates transactions and services between
parties. Various open-source protocols are being developed along with public blockchains,
Journalof Financial Crime
Vol.30 No. 1, 2023
pp. 97-113
© Emerald Publishing Limited
DOI 10.1108/JFC-09-2021-0218
The current issue and full text archive of this journal is available on Emerald Insight at:
creating a foundation for decentralized nancial activity (Gudgeon et al., 2020b). There are
two fundamental components to enable a nancial system to function; it requires a
functioning infrastructure and a currency. Banks and nancial institutions operate in
a centralized system,whereas federal funds serve as currencies like the US dollar. To deliver
a comprehensive rangeof nancial services,DeFi must replace these components.
Ethereum is a decentralized programme-writing platform. It can construct intelligent
contracts using Ethereum automated code that can be used in nancial services
management. You may lay down rules for how a nancial service function and apply the
regulations in Ethereum using smartcontracts. It cannot be amended after a smart contract
is implemented. To construct any nancialservice, users may build decentralized Ethereum
apps and allow intelligentcontracts for the independent administrationof these services.
However, a stable currency is needed to build a dependable, secure dece ntralized nancial
system.A stable coin is a cryptocurrency thatequals a at currencyin its value. For example,
DAI is a decentralized stable coin attached to the US dollar, meaning that 1 DAI represents US
$1 equivalent. The value of DAI is not directly supported by US dollar reserves but by
cryptocurrency collateral (Chohan,2021a, 2021b). DAI could be used for DeFi.
The advantages of a decentralized nancial system go beyond internet payments. The
transfer of money is only one part of the traditionallycentred nancial system, but excellent
nance, encompassing exchange, loans, insurance and saving plans, is intended to replace
every aspect.
Smart Ethereum contracts enable these decentralized services to exist and to function
fairly and safely. Some Ethereum-supportednancial services already in place: You may get
a loan in minutes using decentralized nancing without a complex or restrictive method.
The compound is an Ethereum software for decentralized borrowing and lending on a peer-
to-peer basis. Compound links lenders to borrowers automatically and handles lending
automatically with intelligentcontracts (Abdulhakeem and Hu, 2021). The popularity of so-
called yield farminghasincreased because everyone may lend their crypto assets and earn
interest in the process. You may also use the compound as collateral and borrow money
from it to deposit your cryptocurrency.
Without the need for an exchange operator,decentralized exchange (DEX) permits us to
buy, sell, and trade cryptocurrencies on the Ethereum network, without any signup or I.D.
check and any withdrawing funds fees. In addition, unlike centralized exchanges, trading
using DEX requires no upfront investment. Trades are carried out autonomously and are
controlled by intelligent contracts in terms and processes. The decentralized nancial
systems intelligent contracts also make decentralized, peer-to-peer insurance viable. It can
be used to connect with anybody acrossthe globe who is ready to cover your assets under a
decentralized nancial system.On the other hand, you can ensure the assets of others for a
premium without the need to have an insurance business or agent (Calcaterra and Kaal,
2021). All occurs independently and using intelligent contracts that provide a fair, safe and
reliable procedure.
1.3 Further development and outlook
As a new model for many nancial processes, DeFi has gathered considerable advertising,
investing and crypto-development. As DeFi models, technology and players are so unique;
authorities have so far been little involved. Regulators most likely will not overlook the
hazards of these non-regulated nancial markets much longer, though. To develop a route
towards more user acceptability, the DeFi sector has to grasp compliance requirements.
Financial services have alwaysdepended on intermediaries to broker transactions between

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