Use of DeFi Protocols for Money Laundering Grew in 2021

Decentralized Finance (DeFi) protocols are fast becoming an alternate channel for money laundering, according to a new report by crypto forensics firm Chainalysis. Illicit wallets sent 17% of all their funds through DeFi protocols in 2021, an increase of 1,964% from 2020 levels, the report states.

DeFi protocols are communication standards used between services, generally DeFi platforms, operating in a distributed network. While the use of such protocols for money laundering surged during the pandemic, centralized cryptocurrency exchanges remained the favored conduit and accounted for 47% of all funds laundered using cryptocurrencies. Other popular methods in the cryptocurrency ecosystem used for money laundering include mining pools, high-risk exchanges, and cryptocurrency mixers.

On an overall basis, there was a 30% increase in money laundering activity to $8.6 billion last year. Despite the rise, money laundering was just 0.05% of the total transaction volume in cryptocurrency in 2021. Trading accounted for an overwhelming majority as investors, retail and institutional, poured money into risky assets in a pandemic environment characterized by low interest rates and stimulus money.

A Popular Platform for Money Laundering 

The increasing share of DeFi protocols in money laundering has occurred in parallel with a mainstreaming of cryptocurrency exchanges. The pandemic proved to be a watershed moment in crypto fortunes, and the popularity of these exchanges exploded. An increase in customer numbers, however, has been accompanied by greater regulatory scrutiny and spotlight, making it difficult for criminals to use them to siphon funds across geographies. 

DeFi protocols, which aim to decentralize financial transactions by removing third-party intermediaries, have escaped regulatory censure thus far even though investors are not shying away from the platforms. According to data from online publication The Block, $192.82 billion was locked in DeFi protocols, as of Jan. 27, 2022. That’s down from a high of $256 billion in December 2021.

While they have attracted funds, DeFi platforms are also more vulnerable than cryptocurrency exchanges because they are still under development. In fact, a January Chainalysis report found that they accounted for $2.2 billion out of the $3.2 billion worth of cryptocurrency stolen in 2021. 

According to the latest report, DeFi protocols became especially popular with hackers during the pandemic. Blockchain addresses associated with theft sent under half of their stolen funds— amounting to $750 million—to DeFi platforms. Hackers in North Korea used DeFi protocols “quite a bit,” the report states. “This may be related to the fact that more cryptocurrency was stolen from DeFi protocols than any other type of platform last year,” the authors write.

Will DeFi Protocols Remain Popular for Money Laundering?  

For the most part, cryptocurrency entrepreneurs have struck a defiant stance against regulation and consider existing rules, which require customer identification and registration of transaction information, a “dramatic failure.” As long as DeFi platforms remain outside the regulatory ambit, they will continue to be popular with criminals for money laundering.

However, the current state of affairs might not last a long time. Already, regulators have sounded warnings. In September last year, U.S. Comptroller of Currency Michael Hsu said that controversial DeFi activities were similar to Wall Street practices that led to the 2008 financial crisis. SEC chief Gary Gensler has also said that DeFi is not above regulation.