U.S. Treasury Eyes Digital Identity in DeFi as a New Weapon Against Money Laundering and Terrorism

The U.S. Department of the Treasury has launched a public consultation on the potential introduction of digital identity into the world of decentralized finance (DeFi). The aim is to curb illicit financial activities – from money laundering to terrorist financing.

Digital Identity Embedded in Smart Contracts One of the Treasury’s proposed approaches is to integrate identity checks directly into DeFi smart contracts. Under this model, transactions would only be executed after the user’s identity is verified — through government-issued IDs, biometric data, or portable digital credentials. This would essentially build KYC (Know Your Customer) and AML (Anti-Money Laundering) mechanisms into the blockchain infrastructure itself. According to the Treasury, such solutions could not only enhance security but also reduce compliance costs while potentially giving users greater privacy protections.

Response to the GENIUS Act The consultation follows the July passage of the GENIUS Act (Guiding and Establishing National Innovation for US Stablecoins Act), which sets the regulatory framework for payment stablecoin issuers. The law also directs the Treasury to explore new technologies for regulatory oversight, including artificial intelligence, APIs, blockchain monitoring, and digital identity verification. The Treasury noted that digital identifiers could help institutions flag suspicious transactions before they occur. Still, it acknowledged key challenges ahead — particularly regarding data privacy and the need to balance innovation with regulation. Feedback from the public and industry stakeholders will be accepted until October 17, after which the Treasury will submit a report to Congress and may issue new guidance or propose fresh rules.

Banks Warn of a Loophole in the Law U.S. banking groups, led by the Bank Policy Institute (BPI), have raised concerns about a potential loophole in the GENIUS Act. While stablecoin issuers are barred from paying interest to token holders, crypto exchanges and their affiliates are not covered by this restriction. BPI warned that this could allow stablecoins to offer yields indirectly through exchanges, undermining the credit system. The group estimates that such a shift could lead to a massive outflow of deposits from traditional banks — as much as $6.6 trillion — putting further strain on the banking system during times of stress.

A Threat to the U.S. Credit System Banks caution that unless the loophole is closed, the U.S. economy could face higher interest rates, reduced access to loans, and greater financial burdens for households and businesses. Ultimately, this could weaken not only the stability of the banking sector but also the broader U.S. economy.

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