US Treasury weighs digital ID verification in DeFi to tackle illicit finance

The US Department of the Treasury is seeking public feedback on how digital identity tools and other emerging technologies could be used to fight illicit finance in crypto markets, with one option being embedding identity checks into decentralized finance (DeFi) smart contracts.

The consultation, published this week, stems from the newly enacted Guiding and Establishing National Innovation for US Stablecoins Act (GENIUS Act), signed into law in July.

The Act, which sets out a regulatory framework for payment stablecoin issuers, directs the Treasury to explore new compliance technologies, including application programming interfaces (APIs), artificial intelligence, digital identity verification and blockchain monitoring.

One of the ideas in the request for comment is the potential for DeFi protocols to integrate digital identity credentials directly into their code. Under this model, a smart contract could automatically verify a user’s credential before executing a transaction, effectively building Know Your Customer (KYC) and Anti-Money Laundering (AML) safeguards into blockchain infrastructure.

Treasury considers digital ID verification in DeFi. Source: Laz

Related: GENIUS Act to spark wave of ‘killer apps’ and new payment services: Sygnum

Treasury: digital IDs could cut compliance costs

According to Treasury, digital identity solutions, which may include government IDs, biometrics or portable credentials, could reduce compliance costs while strengthening privacy protections.

They could also make it easier for financial institutions and DeFi services to detect money laundering, terrorist financing, or sanctions evasion before transactions occur.

Treasury also acknowledged potential challenges, including data privacy concerns and the need to balance innovation with regulatory oversight. “Treasury welcomes input on any matter that commenters believe is relevant to Treasury’s efforts,” the agency wrote.

Public comments are open until Oct. 17, 2025. Following the consultation, Treasury will submit a report to Congress and may issue guidance or propose new rules based on the findings.

Related: GENIUS Act yield ban may push trillions into tokenized assets — ex-bank exec

US banks warn against stablecoin yield loophole

Last week, several major US banking groups, led by the Bank Policy Institute (BPI), urged Congress to tighten rules under the GENIUS Act, warning that a loophole could let stablecoin issuers bypass restrictions on paying interest.

In a letter sent Tuesday, BPI said the gap could allow issuers to partner with exchanges or affiliates to offer yields, undermining the intent of the law. The group cautioned that unchecked growth of yield-bearing stablecoins could trigger up to $6.6 trillion in deposit outflows from traditional banks, threatening credit access for businesses.

Magazine: Bitcoin vs stablecoins showdown looms as GENIUS Act nears