Crypto Industry Advocates for Native Solutions to Combat Illicit Finance with U.S. Treasury

Executive Summary

Paradigm, the Digital Frontier Foundation (DEF), and the Stanford Internet Observatory (SPI) have jointly submitted proposals to the U.S. Treasury Department, advocating for the adoption of crypto-native solutions to combat illicit financial activities within the digital asset sector. This engagement, in response to a request concerning the implementation of the GENIUS Act, seeks to influence the development of future U.S. regulatory frameworks for digital assets. The initiative contributes to a cautious market sentiment due to the potential for new compliance burdens despite aiming for enhanced regulatory clarity.

The Event in Detail

In response to a request for comment from the Treasury Department regarding "innovative or novel methods...to detect illicit activity involving digital assets" under the GENIUS Act, Paradigm, DEF, and SPI presented a comprehensive strategy. Their submission champions a "defense in depth" approach, proposing a multi-layered system of tools to mitigate illicit finance. These solutions are categorized into three primary types: risk assessment and defensive blocking tools, proactive user-protection tools, and threat information coordination solutions.

Risk assessment tools involve evaluating potential threats through reputational due diligence, including the analysis of wallet history and token legitimacy to generate quantifiable risk scores. Defensive blocking mechanisms provide proactive barriers, such as screening transactions in real time and halting bots or exploits. Proactive user-protection tools include transaction simulation, allowing users to foresee the outcomes of their transactions. Threat information coordination solutions, exemplified by the Security Alliance (SEAL), focus on sharing intelligence, facilitating emergency responses, and developing industry security standards through services like SEAL 911.

The groups emphasized that illicit finance within the crypto ecosystem constitutes a small percentage of total crypto volume, ranging from 0.014% to 0.4% in 2024, according to data from TRM Labs and Chainalysis. This figure is notably lower than the 2-5% of global GDP estimated for money laundering in the traditional financial system. Furthermore, illicit volumes in crypto experienced a 51% reduction between 2023 and 2024, as reported by Chainalysis, with illicit on-chain transactions accounting for 0.14% in a 2025 report, down from 0.34% in 2024. This data underpins their argument that crypto-native tools offer the most effective means to address the issue.

Financial Mechanics and Industry Strategy

The proposed "defense in depth" framework intends to leverage the inherent transparency and traceability of blockchain technology to create a more secure digital asset environment. By focusing on crypto-native solutions, the industry seeks to demonstrate its capacity for self-regulation and innovation in combating financial crime. The strategy suggests that tailored blockchain analytics and on-chain monitoring capabilities can surpass the effectiveness of traditional financial crime prevention methods within the crypto context.

However, the ongoing push for increased regulation and enhanced security measures carries significant financial implications for the industry. Compliance budgets are under pressure, with Anti-Money Laundering (AML) and Know Your Customer (KYC) protocols consuming 34% of compliance expenditures. Decentralized Finance (DeFi) platforms have experienced a 19% rise in operational costs, driven by demands for real-time audit trails and stricter on-chain reporting mandates. Furthermore, U.S. exchange registration fees average $120,000 per state, increasing the regulatory entry barrier for new ventures. The industry has also seen a 75% increase in cybersecurity spending, with firms allocating up to 18% of their annual budgets to meet compliance-grade standards. These rising costs contribute to a 12% drop in DeFi total value locked (TVL), particularly in lending and derivatives protocols, underscoring the economic impact of regulatory and compliance hurdles.

Market Implications

The engagement by Paradigm, DEF, and SPI is poised to significantly influence the development of U.S. regulatory frameworks for digital assets. By advocating for crypto-native solutions, the industry aims to foster clearer guidelines for anti-illicit finance measures, which could standardize security practices and enhance user protection across the ecosystem. This proactive participation in policy-making signals a maturing industry prepared to collaborate with regulators.

In the short term, the ongoing discussions introduce a degree of uncertainty into the market. While the ultimate goal is to improve security and regulatory clarity, the potential for new compliance burdens and operational changes contributes to a cautious market sentiment. Long-term, such initiatives could pave the way for greater institutional adoption of digital assets by addressing regulatory concerns and establishing robust security standards. However, the increased costs associated with compliance may also impact smaller projects and startups within the Web3 ecosystem.

Broader Context

This initiative positions the crypto industry as a proactive participant in defining its regulatory future, asserting that the transparent and traceable nature of blockchain transactions provides superior tools for detecting and preventing illicit activities compared to conventional financial systems. Industry figures like Justin Slaughter, Policy Director at Paradigm, are actively involved in shaping this narrative, emphasizing that the inherent characteristics of crypto offer the most effective solutions for challenges within its own domain. The submission highlights a fundamental argument that combating illicit finance effectively within the digital asset space necessitates a deep understanding and utilization of its unique technological properties rather than imposing traditional finance regulations without adaptation.