US Treasury’s Exploration into Identity Checks in DeFi
The US Treasury is examining the possibility of integrating identity checks directly into decentralized finance (DeFi) smart contracts, a proposition that critics argue could fundamentally alter the principles of permissionless finance.
Last week, the agency initiated a consultation under the Guiding and Establishing National Innovation for US Stablecoins Act (GENIUS Act), which was enacted in July. This Act mandates the Treasury to assess new compliance mechanisms aimed at combating illicit finance within crypto markets.
One of the suggested approaches involves incorporating identity credentials directly into smart contracts. This would mean that a DeFi protocol could automatically verify a user’s government-issued ID, biometric credentials, or digital wallet certificate before permitting a transaction to occur.
Proponents maintain that integrating Know Your Customer (KYC) and Anti-Money Laundering (AML) checks into blockchain infrastructure could enhance compliance and deter criminals from engaging in DeFi.
Fraser Mitchell, Chief Product Officer at AML provider SmartSearch, stated that such tools could “unmask the anonymous transactions that make these networks so attractive to criminals.”
“Real-time monitoring for suspicious activity can make it easier for platforms to mitigate risk, detect, and ultimately prevent money launderers from using their networks to wash the proceeds from some of the world’s worst crimes,” Mitchell mentioned.
Related: GENIUS Act to spark wave of ‘killer apps’ and new payment services: Sygnum
Mitchell recognized the privacy tradeoff but contended that viable solutions exist. “Only the necessary data required for monitoring or regulatory audits should be stored, with everything else deleted. Any data that is retained should be encrypted at the row level, reducing the risk of a major breach.”
Concerns from Critics
Nonetheless, critics argue that this proposal threatens to undermine the essence of DeFi. Mamadou Kwidjim Toure, CEO of Ubuntu Tribe, likened the initiative to “putting cameras in every living room.”
“On paper, it looks like a neat compliance shortcut. But you turn a neutral, permissionless infrastructure into one where access is gated by government-approved identity credentials. That fundamentally changes what DeFi is meant to be,” Toure remarked.
He cautioned that if biometric or government IDs become linked to blockchain wallets, “every transaction risks becoming permanently traceable to a real-world person. You lose pseudonymity and, by extension, the ability to transact without surveillance.”
For Toure, the implications extend beyond compliance issues. “Financial freedom relies on the right to a private economic life. Embedding ID at the protocol level erodes that and creates dangerous precedents. Governments could censor transactions, blacklist wallets, or even automate tax collection directly through smart contracts.”
Exclusion and Data Security Concerns
Another significant concern is exclusion. Billions of individuals worldwide still lack formal identification. If DeFi protocols mandate government-issued credentials, complete communities, including migrants, refugees, and the unbanked, risk being excluded.
“It may restrict access for users who prefer anonymity or cannot meet ID requirements, limiting DeFi’s democratic nature,” Toure noted.
Data security is also a critical issue. Connecting biometric databases to financial activities could lead to more severe hacks, compromising both funds and personal identities in a single breach.
Critics emphasize that the choice isn’t merely between crime havens and mass surveillance. Privacy-preserving tools like zero-knowledge proofs (ZKPs) and decentralized identity (DID) standards present ways to verify eligibility without disclosing complete identities.
With ZKPs, users can demonstrate they are not on a sanctions list or are over 18 without revealing their identities. DID frameworks allow users to possess verifiable credentials and selectively disclose them. “Instead of static government IDs, users hold verifiable credentials they selectively disclose,” Toure explained.
