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Why does decentralized finance often get associated with illicit activities?

If you are a fan of crime TV series involving technologically-savvy detectives, you probably are familiar with the popularity of “bitcoins” (actually, these TV series are referring to cryptocurrencies, but in order to simplify, they will simply mention the most popular type) in the series’ plotlines. 

But wait, the word “popular” is not really that accurate to refer to the frequent references to cryptocurrencies in these TV series, perhaps “notorious” is more accurate, as in these TV series, the cryptocurrencies (usually the bitcoin) are being used for illicit activities from drug trading to organ trafficking.

The portrayal of cryptocurrencies in these TV series can lead to a logical fallacy, leading people to believe that cryptocurrencies are indeed the most potent tools of crime in our time, because it somehow involves a complicated technology that is understood by only a handful of people, making it the best platform to go underground and evade the authorities. But, is it true?

Before we address the question, let us remember once again that cryptocurrency is the type of money we use in decentralized finance or DeFi, part of blockchain technology. Basically DeFi removes the traditional intermediaries of financial transactions: the government, banks and even fintech operators. 

In DeFi, transactions are conducted in the peer-to-peer (P2P) network using “smart contracts” — a series of actions coded into the P2P network based on a consensus reached by all parties involved in the transaction, instead of having just one single authority determining transaction terms and conditions. 

So, is it true that DeFi, including the cryptocurrency, is the perfect tool for crime as depicted in these detective series? We will explore this question in this article, which will be divided into three parts:

  • Traceability in decentralized finance,
  • The advantages of DeFi over conventional financial systems, and
  • The need for a DeFi regulatory framework.

Traceability in decentralized finance

Let us address the issue straight. When we read news items about illicit gangs being tracked down by the cryptocurrency transactional footprint they leave behind in the blockchain P2P network, stories which also make their way into the plotlines of the TV series I mentioned earlier, it is not because it is easier to conduct illicit transactions through the blockchain but because the nature of the P2P network makes it easier for authorities to track these transactions down.

By definition, the P2P system records all the transactions that are going on there in an immutable record in the blockchain system, which cannot be taken down. This way, it is easier to trace these illegal transactions through the blockchain system, making it easier for the authorities to map out the entire crime network. When people distribute their illicit funds in cash or through small banks which brand names sound dubious, it is actually much harder to track individuals involved in these transactions down. 

Simply put, the cryptocurrency is no more convenient method of conducting illegal transactions than any other means because it is “an esoteric kind of new technology” and let’s face it, illegal transactions have been going on around the world through various means through time. It just happens that besides the novelty of  cryptocurrency, transactions conducted over there are also easier to track down and this is why these transactions make for a good story, either in news items or TV series.

In reality, as a matter of fact, defi-related crimes made up only one percent (US$34 million) of total transactions in the decentralized exchange (DEX) throughout 2020, as revealed by a blockchain analysis firm called Chainanalysis.

Other advantages of DeFi

Because the blockchain automates transactions using the smart contracts, transactions through DeFi can actually be completed in a much faster, more efficient manner. Furthermore, given that there are no coding or logical mistakes in the system, decentralized finance can also minimize human error in these transactions, thus giving all parties involved more certainty regarding their activities.

The need for a regulatory frameworks

We have mentioned before that it was only recently that DeFi has become a mainstream thing and that regulators are still not adept in understanding the new technology in order to come up with strong regulations to prevent its misuse. Therefore, in order to mitigate possibilities of people using DeFi to conduct harmful or illegal activities such as financing terrorist groups or trading rare animals clandestinely, a policy framework on legal measures to prevent and mitigate these activities has to be available. This would require active dialogue among blockchain practitioners, policymakers and other relevant parties.

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