"Oracle: The Key to AML Compliance in DeFi"

Oracle Can Be a Go-To Solution for AML in DeFi – This Is How

DeFi (decentralized finance) and AML (anti-money laundering) policies have historically been difficult to align. While regulators and industry players advocate for the importance of regulation, implementing effective oversight in the DeFi space has proven challenging. Stolen funds continue to be laundered through DeFi tools, raising concerns about the sector's compliance with legal obligations.

One potential solution to this issue is the use of oracles. Traditional AML policies struggle to adapt to the DeFi ecosystem due to the limitations of smart contracts. Smart contracts are limited to the data available on the blockchain they run on and cannot directly access data from other blockchains or external sources. This is because smart contracts are executed by blockchain nodes, which do not have built-in internet connectivity and can only connect to their own blockchain.

DeFi oracles play a key role in addressing this challenge. Oracles allow DeFi applications to bring in external data to the blockchain, enabling blockchain transactions to achieve consensus with this off-chain information. This information can include data from an AML platform, such as KYC (know your customer)/KYB (know your business) information, watchlists, blacklists, sanctions lists, transaction monitoring, and transaction screening/filtering.

The diagram below depicts how the AML oracle for DeFi works. The process involves six steps:

1. User interacts with DeFi service: Users engage with the DeFi service to perform common financial actions such as depositing, withdrawing, swapping, lending, or staking assets. Before processing the transaction, the DeFi service must ensure the transaction complies with AML regulations.

2. DeFi service request to the AML oracle: When a user initiates a transaction, the DeFi service requests an AML check for the user’s address and the associated data. The DeFi service communicates with the AML oracle smart contract, asking for the KYC/KYB assessment result and a transaction risk rating or address risk rating.

3. External AML provider monitors the AML oracle requests: The external AML provider continuously monitors the AML oracle smart contract for incoming requests from DeFi services. Once the external AML provider detects a request, it begins the AML check based on the specific details provided in the request.

4. External AML provider screens blockchain and off-chain data: