Decentralized finance (DeFi) and anti-money laundering (AML) regulations don’t always mix. It’s tough to enforce AML rules in the decentralized world, leading to stolen funds being laundered through DeFi platforms. So how do we keep DeFi decentralized while still following the law? Oracles offer a promising solution.
Why Traditional AML Fails in DeFi
Traditional AML methods struggle in DeFi because smart contracts can’t access information outside the blockchain they operate on. They can’t check things like KYC/KYB data or sanctions lists. This is a deliberate security feature; allowing smart contracts internet access would create major security vulnerabilities. All transaction data needs to be on the blockchain for everyone to agree on its validity.
Oracles: Bridging the Gap
This is where oracles come in. They fetch external data and bring it onto the blockchain, enabling AML checks within DeFi transactions. This data can include KYC/KYB info, watchlists, sanctions lists, and more.
How a DeFi AML Oracle Works: A Step-by-Step Guide
Here’s how an AML oracle integrates into a DeFi transaction:
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User Interaction: A user initiates a DeFi transaction (deposit, swap, etc.).
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AML Check Request: The DeFi service requests an AML check from the oracle, providing the user’s address and relevant data.
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Oracle Receives Request: An external AML provider monitors the oracle and receives the request.
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Data Analysis: The provider checks both on-chain (transaction history, addresses) and off-chain (sanctions lists, KYC data) information.
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Oracle Response: The provider sends the AML check result (pass/fail) to the blockchain.
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Transaction Completion: The DeFi service automatically acts on the result. A “pass” allows the transaction; a “fail” stops it.
Atomic Transactions: All these steps happen as an atomic transaction – either everything succeeds, or nothing does. This ensures data integrity and prevents partial transactions. For example, if a user is on a sanctions list, the transaction is automatically canceled.
The Bottom Line
DeFi can integrate effective AML solutions, though it will take time and effort. Oracles currently offer a strong technical solution for bringing AML compliance to the decentralized world.