U.S. Treasury Seeks Public Input on Digital Identity Integration in DeFi to Combat Illicit Finance

The U.S. Department of the Treasury has initiated a public consultation to explore how digital identity verification tools can be integrated into decentralized finance (DeFi) platforms to combat illicit financial activity. The initiative, part of the regulatory framework outlined in the newly enacted Guiding and Establishing National Innovation for US Stablecoins Act (GENIUS Act), aims to leverage emerging technologies such as smart contracts, digital identity credentials, and blockchain monitoring to enhance compliance in the crypto space [1].

The consultation, which is open until October 17, 2025, invites input on the potential for embedding Know Your Customer (KYC) and Anti-Money Laundering (AML) safeguards directly into DeFi protocols. Under the proposed model, smart contracts could be programmed to verify user identity credentials automatically before executing transactions. This would introduce a new layer of security while maintaining the decentralized nature of the platforms [1].

Digital identity solutions, which may include government-issued IDs, biometric data, or portable credentials, are seen as a way to reduce compliance costs while improving privacy and fraud detection. The Treasury noted that these tools could help financial institutions and DeFi services identify and prevent money laundering, terrorist financing, or sanctions evasion before transactions occur [1].

However, the agency also acknowledged the challenges involved, including data privacy concerns and the need to balance innovation with regulatory oversight. Treasury emphasized its openness to feedback and indicated it will submit a report to Congress following the consultation period. Based on the findings, the agency may issue guidance or propose new rules to strengthen compliance in the DeFi sector [1].

This development comes as major U.S. banking groups, led by the Bank Policy Institute (BPI), have raised concerns about potential loopholes in the GENIUS Act that could allow stablecoin issuers to offer interest-bearing products. These groups warned that such practices could lead to significant deposit outflows from traditional banks and threaten credit access for businesses [1].

The move reflects broader regulatory efforts to adapt to the rapidly evolving crypto landscape, with the U.S. government prioritizing structural reforms over direct market intervention. While the details of the proposed digital ID framework remain under consideration, the initiative highlights the increasing importance of balancing innovation with accountability in the DeFi space [1].

Sources:

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