Circle Highlights Role of Innovative Technology in Addressing Illicit Finance

As part of President Biden’s Executive Order on Ensuring Responsible Development of Digital Assets, the U.S. Department of the Treasury solicited wide-ranging responses from the public on digital-asset-related illicit finance and national security risks, as well as on the Treasury Department’s recently released action plan to mitigate those risks. On November 3, Circle submitted its response, which highlighted the complex intersection of policy priorities in balancing the continuous development of industry-wide market integrity and compliance tools, technologies, and standards while keeping blockchain-based finance open, secure, and universally accessible. Innovations in compliance technology are paving the way for more effective risk management that safeguards user privacy and dispels the notion of a tradeoff between innovation, inclusion, and integrity.

Circle continues collaborating with government and industry peers to develop and implement digital identity tools to protect user privacy while remaining compliant with anti-money laundering (AML) and combatting the financing of terrorism (CFT) standards. Circle and leading Virtual Asset Service Providers (VASPs) have published Verite, a set of free, open-source decentralized identity protocols and data models. While Verite is still in its early phases, ideally, the decentralized digital identity model will provide verifiable identification that's scalable, easy-to-use, and interoperable across systems, while providing individuals the certainty that only a minimal amount of information is being shared. 

Circle is pleased to participate in this ongoing dialogue with public authorities, and appreciates the Treasury Department’s efforts to comprehensively map and assess the risks that illicit actors pose to the safety and soundness of the digital assets market. While the use of digital assets for money laundering remains far below that of fiat currency, the industry and authorities have made strides in identifying the range of extant threats and vulnerabilities to digital asset markets, while establishing a helpful foundation for AML/CFT risk management efforts. Further steps to engage the digital asset industry, develop identity or other AML/KYC tools, and coordinate international AML/CFT standards will aid the private sector and U.S. government in the detection and reporting of illicit financial activity.

CIRCLE’S KEY POINTS

Market demand has encouraged the development of new technologies that safeguard a user’s privacy while remaining compliant with AML/CFT obligations. Engaging industry and supporting the development of digital identity tools and international standards would aid both the private sector and U.S. government in the detection and reporting of illicit financial activity while preserving end user privacy. 

• “Ideally, a digital identity model would provide a verifiable and proven identification that is scalable, usable by anyone, and interoperable across systems, while also providing individuals the certainty that only a minimal amount of information will be shared. Such systems are possible via cryptographic proofs, and promise to overcome the current inefficiencies and risks associated with data silos maintained by financial institutions.” 
• “Should free, open source decentralized identity protocols like Verite reach widespread adoption, illicit actors would face increased friction when trying to operate without a verified identity, though international standards would need to be well-enforced so as to prevent illicit actors from moving to more lax jurisdictions.”

There is a clear demand for dialogue with the Treasury Department to identify more surgical approaches to render illicit actors unable to use designated services while mitigating the impact of similar sanctions designations on licit users. Proactive guidance from the Treasury at the time of designation could mitigate many of the unintended consequences of sanctions and instead truly target illicit entities.

• “Sanctions are an ineffective way to communicate Treasury policy to the private sector. While sanctions have been shown to disrupt illicit actors, most frequently, such actors reconstitute their operations through other permissive environments. This makes the enforcement of AML/CFT standards worldwide even more important, as illicit actors will look for permissive jurisdictions to continue their activity.”
• “Recent Treasury action on a privacy mixer raised new compliance challenges that do not exist in traditional finance. Further guidance with respect to mixers and anonymity-enhancing services would aid VASPs in developing risk-based compliance regimes and avoiding de-risking of customers, services, or protocols because of overcompliance or based on risks that could be effectively managed with existing digital identity tools.”

Nowhere are the novel challenges to addressing illicit finance manifested more clearly than in Decentralized Finance (DeFi), where individual users conduct transactions without intermediaries capable of performing standard AML processes. Permissioned DeFi pool standards for users with digital identity credentials could provide a way to mitigate potential illicit activity.  

• “Permissioned DeFi pool standards for users with digital identity credentials could provide a way to mitigate potential illicit activity. Of course, the benefits of limiting illicit activity through such a feature should be sought without eliminating the wider utility of permissionless DeFi to revolutionize financial access and frictionless lending and borrowing, and must be considered in this context.”

The U.S. government should continue to play an active role in standard setting by promoting global implementation of FATF standards and conducting targeted engagement to address discrepancies in AML/CFT regulation. 

• "We encourage the Treasury Department to take a demand-focused approach and prioritize jurisdictions where there are large volumes of individual transfers – such as remittances – from the United States or growing local reliance on mobile or digital payments services. Focusing on the materiality of the cross-border payment and remittance industry would suggest that emphasis should be placed on the Middle East, Africa, and Latin America where remittances saw upwards of 20% growth in 2021.”

Circle’s full responses are available here.