The Future of AML: From Suspicious Activity Reports to On-Chain Alerts

The legacy Suspicious Activity Report (SAR) system is a compliance theater. It's a post-transaction black hole where data goes to die, creating $3B+ in annual compliance costs for financial institutions with minimal actionable intelligence for law enforcement.

• <1% of SARs lead to prosecution.
• 30-60 day lag between crime and report.
• Creates massive false positive burden for legitimate users.

Smart contracts enable real-time, logic-based compliance. Protocols like Aave and Compound can bake AML rules (e.g., OFAC lists) directly into their lending logic, preventing non-compliant interactions at the protocol layer.

• Sub-second policy enforcement.
• Deterministic outcomes replace human judgment.
• Enables granular, product-level risk policies (e.g., stricter rules for leveraged yields).

The compliance burden and liability pivot from centralized exchanges (Coinbase, Binance) to the DeFi protocol developers and governance token holders. This forces a new model where code is the primary compliance officer.

• Uniswap DAO now debates sanction compliance.
• Layer 1s like Ethereum become the new regulated 'financial institutions'.
• Automated, transparent rule-setting via governance votes.

Suspicious Activity Reports are filed and vanish into a regulatory void, with <5% ever investigated. This creates massive overhead for protocols like Aave and Compound with zero actionable feedback.

• No Feedback Loop: Firms spend millions with no insight into efficacy.
• High Latency: Investigations take weeks, allowing funds to vanish.
• Compliance Theater: Activity is flagged, not prevented.

Replace binary blacklists with granular, on-chain risk scores that trigger automated, proportional responses. Think Chainalysis Oracle or TRM Labs data fed directly into smart contract logic.

• Dynamic Limits: Wallets with elevated scores face lower transaction caps.
• Deferred Settlement: Use intents (via UniswapX or CowSwap) to hold risky trades for review.
• Capital Efficiency: Good actors operate unimpeded, reducing false positive drag.

Mandatory, full-KYC for all users kills pseudonymity—a core crypto value. Protocols enforcing blanket surveillance (Circle, Tether) create centralized chokepoints and push activity to harder-to-track chains like Monero or Aztec.

• Centralization Vector: Custodians become de facto permissioners.
• Innovation Drain: Privacy-preserving tech is stifled.
• User Exodus: Drives compliant users to riskier, unregulated venues.

Use ZK proofs (e.g., zkSNARKs) to allow users to prove AML compliance without revealing identity. Projects like Worldcoin (proof of personhood) or Sismo (ZK badges) pave the way.

• Selective Disclosure: Prove you're not on a sanctions list, not who you are.
• Protocol-Native: Compliance becomes a verifiable on-chain state, not an off-chain check.
• Preserves Pseudonymity: Breaks the link between wallet address and real-world identity.

The Tornado Cash sanction set a precedent: sanctioning immutable code. This forces infrastructure providers (Alchemy, Infura, layerzero) to censor, fragmenting network state and creating compliant vs. non-compliant forks of the same chain.

• Sovereign Risk: Your stack's legality changes with a press release.
• Infrastructure Fragmentation: Breaks the concept of a universal state machine.
• Chilling Effect: Developers avoid building permissionless money legos.

Decentralize the critical control points. MEV-Boost relays and shared sequencers (like Espresso or Astria) can be designed with liveness over censorship-resistance, making blanket blacklists technically impossible to enforce.

• Liveness Priority: Validators are incentivized to include valid transactions, not censor.
• No Single Point: No central RPC or sequencer to pressure.
• Aligns Incentives: Network health trumps regulatory overreach.