Canada’s anti-money-laundering watchdog has zeroed in on the cryptocurrency concept of decentralized finance as an increasing area of risk and produced an internal report this year for law enforcement and other government organizations, including counterparts in the Five Eyes intelligence network, The Logic has learned.

Decentralized finance, or DeFi, refers to financial services and platforms with no central administrator, which makes any enforcement challenging. The Financial Transactions and Reports Analysis Centre (FINTRAC)’s targeting of DeFi indicates escalating concern about crypto and increasing regulatory scrutiny.

The Logic learned about FINTRAC’s report through an access-to-information request. The report is titled “Exploring the Money Laundering and Terrorist Financing Activity Implications of Decentralized Finance.”

FINTRAC declined to provide outright access to its report, but The Logic, through its access-to-information request, obtained a slideshow and presentation notes based on it. The slideshow was dated January 2022, although the notes state the report was not yet published at the time.

FINTRAC did not answer questions from The Logic beyond saying that, in addition to Canadian law enforcement and Five Eyes counterparts in Australia, New Zealand, the United Kingdom and the United States, it has also shared the document with the country’s national-security agencies and “select” federal departments.

In the notes, parts of which are redacted, an unnamed FINTRAC staffer began by giving an outline of DeFi, saying that among its most popular applications are exchange platforms—like a Coinbase or Binance, but without an organization controlling it. Such DeFi platforms, the staffer said, “enable users to swap crypto assets with other users without the need of a broker or centralized crypto exchange.”

Most DeFi activity happens on the Ethereum network, founded by Canadian Vitalik Buterin. According to the crypto-analysis firm Elliptic, the value of cryptocurrency held on DeFi services amounted to more than US$247 billion by November 2021, a year-over-year increase of over 1,700 per cent.

In the notes, the FINTRAC staffer says the decentralized nature of DeFi is “important to remember” in discussing the “money-laundering and terrorist-activity financing risks associated with DeFi, as well as discussions surrounding DeFi regulation.”

“Since DeFi platforms do not have Know Your Customer or record-keeping obligations, transactions occur between private and totally anonymous cryptocurrency wallets,” the FINTRAC staffer said.

“This [money-laundering] issue is being exacerbated further as some DeFi platforms are being developed to increase the difficulty in the ability to trace funds.”

The FINTRAC staffer also notes in the presentation that DeFi platforms’ publicly available code makes them vulnerable to hackers.

North Korean hackers, for example, have been accused both of stealing from DeFi platforms and of laundering the funds through other DeFi platforms.

Citing a report by a G7 task force, the FINTRAC staffer added that DeFi poses additional challenges when “there is no clear natural or legal person who maintains sufficient control over the platform.”

That potentially frustrates enforcement. With the recent case of crypto donations to the Freedom Convoy protesters in Ottawa, the federal government’s response was to provide centralized exchange platforms with a blacklist of crypto wallets—which would be impossible with DeFi platforms that have no companies or people to approach.

According to the FINTRAC slideshow, the agency has received reports from partner organizations and the financial-services businesses it regulates that “demonstrate that DeFi is currently, and will continue to be, exploited by malicious actors.”

The slideshow and notes do not appear to outline specific next steps. The April federal budget, however, pledged an extra $89.9 million over five years to FINTRAC, in part to deal with cryptocurrency. The government has also planned a regulatory review of the subject.