Enhancing transparency to prevent financial crimes

International Security Journal hears exclusively from Devin Partida, Editor in Chief, ReHack about enhancing transparency with DeFi protocols to prevent financial crimes.

Transparency and financial crime

Transparency is vital for establishing trust and ensuring accountability. However, it’s missing in many traditional financial systems.

The finer details often get lost among intermediaries or are limited by regulations. Decentralised finance is different.

On account of the blockchain, DeFi is like a glass bank vault. Every participant can see what is going on inside.

Certain DeFi protocols could enhance transparency, improving platform security and preventing financial crimes.

DeFi platforms are inherently transparent

DeFi protocols are standards, rules and procedures that govern decentralised financial applications.

They enable users to trade, borrow and lend directly without an intermediary.

These rulesets are inherently transparent because individuals can always remotely access and verify details about cash flows.

Uniswap is an excellent example. Like other platforms, it has open-source code. Unlike traditional exchanges, it lets holders vote on protocol change proposals, giving them a say in the future of development.

Since Uniswap is noncustodial, users also retain control of their funds throughout the trading process.

DeFi protocols can enhance transparency Many people are hesitant to use cryptocurrency. Although 81% are familiar with it, only 33% have expressed readiness to use it.

This may be because 36% say they are only somewhat confident in its reliability and safety. Another 39% are not at all confident.

This may stem from a lack of knowledge. In reality, these platforms are open and secure.

The blockchain’s immutability ensures every transaction is tamper-proof and publicly verifiable, as they cannot be altered or erased once recorded.

Open-source code allows anyone to inspect applications and smart contracts, enabling independent auditing free from red tape.

These systems ensure traceability and accountability, impeding fraudulent activity.

Blockchain analytics tools and smart contract auditing improve traceability without compromising the decentralised nature of DeFi applications.

Users do not need to rely on a centralised authority or third-party auditors.

Difficulty balancing privacy with openness

While open-source code and traceable cash flows support openness and facilitate independent auditing, they also attract cyber threats.

DeFi applications are particularly vulnerable because of their consolidated value. The total value locked in decentralised lending protocols is more than $169 billion as of 2024.

While the blockchain offers transaction transparency, many users highly value privacy and anonymity. The lack of a centralised authority facilitates money laundering and financial fraud.

Tracing bad actors is difficult since wallet addresses do not contain personally identifiable information.

Even if someone could reliably trace suspicious activity to specific users, DeFi protocols cannot reject potentially illicit transactions unilaterally.

Unlike traditional financial institutions, freezing or shuttering suspicious accounts is not an option.

Ultimately, even if a platform’s elected governance leaders implement a compliance mechanism, fraudsters can bypass anti-money laundering measures by creating a new account or securing a new wallet.

For this reason, advanced DeFi protocols that can increase security and accountability without compromising privacy are vital.

Integrating advanced solutions into protocols

Know Your Customer (KYC) is an identification and verification process that collects basic identifiers to prevent financial crimes.

Discrepancies — such as a mismatched name and birth date — can indicate fraudulent activity.

Regulators are increasingly pushing for DeFi platforms to implement this protocol. No such rule exists yet, but many applications use third-party KYC tools.

Zero-proof knowledge is another advanced protocol that can strengthen compliance without compromising user privacy.

In this architecture, only the prover can convince the verifier that a given statement is true. They can prove the validity of their statement without revealing any details other than the validity of the statement itself.

With zero-proof knowledge, governance leaders and automatic auditors can prove that an individual possesses secret information — like a password, seed phrase or personal identifier — without seeing or storing the data.

Sanctions screening involves checking users’ transaction and account data against a global sanctions list.

Searching for sanctioned individuals, jurisdictions and entities helps governance leaders ensure that no one engages in restricted financial dealings, preventing platforms from being used for illicit or illegal means.

Privacy, security and transparency

While the absence of a central authority enables DeFi applications to be as open as they are, it also makes enforcing anti-money laundering protocols like KYC difficult.

Since no universal regulations exist, users and governance leaders must take it upon themselves to balance privacy, transparency and security.