U.S. Treasury Consults on Digital ID Integration in DeFi to Combat Illicit Finance

The U.S. Department of the Treasury has launched a public consultation under the Guiding and Establishing National Innovation for U.S. Stablecoins Act (GENIUS Act) to explore the integration of digital identity verification within decentralized finance (DeFi) platforms. The consultation, open until October 17, 2025, proposes embedding Know Your Customer (KYC) and Anti-Money Laundering (AML) checks directly into DeFi smart contracts, aiming to automate identity verification prior to transaction execution without compromising the decentralized nature of these systems [1].

Under the proposed model, users could verify their identities using digital credentials such as government-issued IDs, biometric data, or portable identity tools. These methods would enable DeFi platforms and financial institutions to detect and prevent illegal activities, including money laundering, terrorist financing, and sanctions evasion, at the point of transaction initiation [1]. The initiative is designed to reduce compliance costs while maintaining user privacy and improving fraud detection, though the Treasury has acknowledged the inherent challenges, particularly in managing data privacy and ensuring a balanced regulatory framework that supports innovation [1].

The initiative also highlights concerns from traditional banking groups about the potential risks of stablecoin systems, with formal warnings citing the possibility of $6.6 trillion in bank deposit outflows as a reflection of systemic U.S. financial risk channels [1]. The Bank Policy Institute and similar groups have raised the issue of regulatory gaps in the GENIUS Act, arguing that they may allow stablecoin issuers to offer interest-bearing products that could undermine traditional banking systems [1].

No significant responses from major DeFi protocols such as Uniswap, Aave, or Lido have been reported to date. However, the DeFi community remains cautious, with industry analysts warning of potential systemic risks if regulatory gaps are not adequately addressed [1]. The consultation is part of a broader effort to adapt regulatory frameworks to the fast-moving crypto landscape, with the Treasury considering post-consultation actions such as issuing new guidance or proposing updated rules [1].

The proposed digital identity framework represents a pivotal shift toward incorporating modern technology into financial regulation. If implemented, it could significantly reshape DeFi compliance norms, influencing not only DeFi platforms but also the stability and liquidity of the broader crypto market [1]. The outcome of the consultation will determine the trajectory of regulatory approaches in the U.S., balancing innovation with accountability in the decentralized finance ecosystem [1].

Source: [1] https://cointelegraph.com/news/us-treasury-digital-id-defi-illicit-finance