The Future of DeFi AML: Oracle’s One-Stop Tech Solution
DeFi Compliance with Oracle

Various regulatory bodies and organizations, from the U.S. Treasury to the World Economic Forum, advocate regulations for the DeFi sector. This call is justified, as DeFi can be (and is) exploited for money laundering and other illegal financial activities.

But how do we implement these regulations? DeFi operates outside traditional frameworks, and its decentralized protocols and smart contracts can’t align with current regulatory requirements.   

Smart contracts: decentralized, secure, yet limited in getting external data

DeFi smart contracts are run by blockchain nodes. They aren’t connected to the internet and can’t directly get information from other blockchains, websites, or APIs—just from the blockchain they operate on. 

This design has its pros and cons:

  • Pros: The blockchain is kept secure and decentralized. Preventing smart contracts from internet connection shields the system from unreliable or manipulated data from external sources. 
  • Cons: Smart contracts can’t access external data for tasks like AML checks.

Oracles can provide Dapps with external AML data via atomic transaction 

Here, oracles come into play. They provide DeFi apps with external data, such as asset prices or compliance information, e.g., KYC/KYB details, transaction monitoring, screening, watchlists, blacklists, or sanctions lists.

How it works: a 6-step scheme 

  1. User interacts with the DeFi service to deposit, withdraw, exchange, lend, or stake their assets.
  2. Before processing the transaction, the DeFi service checks the user’s address and related data for AML compliance. It connects with an AML oracle smart contract to get the KYC/KYB check results and a risk rating for the transaction or address.
  3. The external AML provider keeps an eye on the AML oracle smart contract for any new requests from DeFi services. When it spots a request, it starts the AML check using the details included in that request.
  4. The external AML provider carries out the AML check by looking at both on-chain and off-chain data. This includes transaction history, wallet addresses, and other blockchain activities; sanction lists, watchlists, and info about suspicious addresses; data from users linked to their blockchain addresses.
GL Counterparty Report with information on sanctioned and other high-risk entities 

GL Counterparty Report with information on sanctioned and other high-risk entities 

  1. Once the check is finished, the provider records the result on the blockchain and shares a reference to this information with the oracle smart contract. The result usually includes a pass or fail status and a link to detailed data stored by the AML provider.
  2. After the AML check result is recorded on the blockchain, the DeFi service follows its smart contract rules to decide whether to continue with the transaction, stop it, or freeze the funds. 
6-step scheme of oracle AML operation

All these steps happen within an atomic transaction, meaning either all steps are completed successfully or none of them happen at all. This keeps the transaction secure and reliable. For example, if a user’s address is found on a sanctions list, the blockchain will automatically cancel the transaction based on its rules without needing any human involvement. This removes the chance of mistakes from system errors or human compliance checks.

To conclude

Oracles can provide decentralized apps not only asset prices, but also AML information. Right now, oracles can be seen as a key technical tool for bringing AML into DeFi, preserving both security and decentralization.