This blog has been written by Bhavya Gupta, 3rd Year law student at Symbiosis Law School, Pune

Introduction and Contextualisation 

In 2025, the global market for decentralised finance (DeFi) is projected to reach $42.76 billion with more than $123.6 billion in total value locked across nations, indicating a transformative shift in the regulatory and industrial landscape due to accelerated convergence of national security concerns with financial technology. The phenomenon of “DeFi Platforms” refers to the concept wherein the emergence of technologies built on blockchain infrastructures and smart contracts. It reshapes global finance through algorithmic driven and borderless networks by eliminating central traditional intermediaries such as regulatory agencies and banks. This disintermediation by technology has led to formation of a parallel financial ecosystem and increased efforts to impose oversight, cross-border cooperation and data-reporting obligations. 

Relevance- The rapid expansion and integration of DeFi into broader financial infrastructures along with its ability to alter the structuring of products such as transfer, risk management and lending on a global level amplifies its relevance in the contemporary era. The growth through DeFi enhances transparency, spur inclusions and innovation but simultaneously creates room for financial crimes, national security threats and systematic risks. The DeFi operates at the intersection of sovereignty, technology and finance making it difficult to regulate within the conventional jurisdictional boundaries and thereby demands risk-based and innovative legal mechanisms that merge counter-terrorism and anti-money laundering financing standards with the structural realities in decentralised systems. 

Scope-In the industrial landscape, decentralised financial technology has emerged as a disruptive force transforming the architecture of global commerce and challenging the traditional financial and regulatory institutions. This essay aims to encapsulate one of the most crucial debates of the 21^st Century, wherein the intersection of national security and financial technology demands new legal and regulatory strategies to safeguard both national interests and financial innovations. The analysis would foreground the concern relating designing interventions in order to reconcile security imperatives with the preservation of economic dynamism, individual financial autonomy and technological innovations. 

Analytical Evolution 

The decentralisation of finance refers to open-sourced and interoperable technological protocols that facilitate financial services including borrowing, trading, asset management and lending through smart contracts without regulation by traditional intermediaries. In the economic sense, the redistribution of DeFi through displacement of centralised institutions with decentralised mechanisms operating on a global level raises serious questions on jurisdictional reach, regulatory enforceability and sovereignty.  This disruptive potential transcends beyond economies, affecting political sovereignty as states face challenges in exerting authority over transnational and disaggregated financial networks as DeFi shifts practical controls away from the regulatory institutions into open-source codes, off-ramps and cross-chain bridges. This consequential combination of potential systematic and technical distinctiveness is the reason why national-security actors now treat DeFi as constructively and strategically important. 

DeFi has joined RegTech (Regulatory Technology), FinTech (Financial Technology), digital assets and cryptocurrencies as one of the most constructive emerging technological evolutions in global financial literacy. Yet very little could be understood about its meaning, policy consequences and legal implications. The pseudonymous and borderless nature of DeFi introduced multifaceted risks and National Security challenges including; 

Illicit Finance and Evasion of Sanctions- The illicit actors, including cyber criminals, ransomware actors and fraudsters tend to abuse DeFi services in order to launder illicit proceeds. The illicit actors use DeFi services to convert one virtual asset into a different virtual asset for a variety of reasons, including to exchange a more liquid asset easier to cash into fiat money. In criminal cases, they may use the decentralised technology to exchange virtual assets with weaker illicit finance migration or with an asset which is less traceable. They take advantage of cybersecurity regulatory gaps, consisting of DeFi services to steal virtual assets. The absence of the government and the oversight limits the real-time surveillance and leads to formation of “dark pools” protected from regulatory action.  This undermines the coercive tools used by states and sanctions, which are primary instruments to counter the same.

According to the Report on “Illicit Finance Risk Assessment of Decentralised Finance” the Democratic People’s Republic of Korea, under pressure from European, United Nations (UN) and U.S.A sanctions regime, is found to engage in illicit finance by increasingly stealing virtual assets from centralised finance and DeFi services.

Cyber-Security Threats and Principle of Data Sovereignty- The principle of Data Sovereignty guides that the data which is generated in or about a state is subject to the laws and governance of the territory of the state, where it is stored, collected or the data-subjects reside. The scholars and policymakers have distinguished between (a) data localisation including mandatory processing or local storage of data and (b) data residency referring to physical location of the data servers with (c) data access sovereignty which extends or empowers the state to control the data irrespective of the location in the true interest of their states. The three concepts are similar but differ in their legal and policy connotations.

The strategic national-security concerns have emerged because modern cyber security threats exploit software supply chains, cloud dependencies, cross-border data flow and limit data governance mechanisms to manipulate, steal or weaponize data. The cyber criminals use Artificial Intelligence (AI) to identify the existing vulnerabilities in DeFi services, and smart contracts to automate exploitation or social engineering campaigns that evade conventional defence systems and challenge the platform regulators and operators to keep pace and certainty. The evolution through AI, deepfake-based impersonation schemes and enhanced malware enable or facilitate the attackers to manipulate user interfaces and trick investors due to regulatory vacuums. 

Studies on AI-driven misinformation suggest that the number of deepfake videos circulating online is projected to rise from roughly 500,000 in 2023 to nearly 8 million by 2025, thereby demonstrating the rapid expansion of synthetic media capable of influencing political discourse and governance mechanisms. Furthermore, large scale data exfiltration and intrusion was carried out by Russia on Ukraine to target government, private industries and critical infrastructures to gain dominance over the sovereignty of the nation.  In order to protect sovereignty, nations like Brazil, India and China have strengthened localization mandates necessitating that the data-generation including transactional and financial records remains within the borders of the nations. 

Regulatory Gaps and Principle of Jurisdictional Sovereignty 

The architectural landscape under the DeFi services often runs through blockchain-based entities known as “Decentralized Autonomous Organizations” (DAOs) that operate without any central or identifiable legal authority, which could be held liable or is required to ensure compliance with “Anti-Money Laundering ” (AML) or the laws “Countering the Financing of Terrorism’’ (CFT). The borderless transactions make it extremely difficult for the agencies to assert their jurisdiction or enforce any regulatory requirement as national authorities have limited reach over individuals and entities in other jurisdictions, especially in cases wherein locations, device data and user identities are untraceable. This weakness and failure of traditional regulatory mechanisms like transaction monitoring or KYC checks could allow sanctioned or illicit actors to use parallel financial mechanisms or anonymised tools to evade economic coercion or move funds. Even though the guidelines issued by the FATF stresses on the jurisdictions to capture the functional transactions, the very design of the DeFi services frustrates that approach.

After the 2020 case of bZx Protocol Attack, wherein the attacker siphoned hundreds of dollars through a flaw in smart contract code and left users without any legal recourse due to absence of any compensating or regulatory authority, the authorities such as US Treasury, Financial Action Task Force (FATF), European Banking Authority (EBA) and European Securities and Markets Authority (ESMA) have consistently highlighted how protocols under DeFi services could be harnessed by hostile state actors for circumventing sanctions and financing terrorism. The 2025, Risk Assessment Report by the UK detailed how the lack of institutional-level controls and anonymity elevated the risk for terrorism through channels of technology. In United States v. Microsoft Corp, it was held that the courts should not unilaterally attempt to expand territorial doctrines, instead legislatures and executives must craft constructive cross-border frameworks. 

In US v. Avraham Eisenberg, 2025, the convictions for fraud and manipulation through DeFi platform was vacated by the District Court of US not on the substance but on the standing that the New York lacked proper venue and jurisdiction since Eisenberg conducted his trade deeds from Puerto Rico and the Government failed to show any substantial nexus or connection with New York. In the cases of DeFi platforms wherein no geographic anchor or central authority exists in its conventional sense and users are free to operate from anywhere in the world, this judicial decision underscores the challenge of determining the location of the proceedings as well as the grounding jurisdiction for the same.  

Existing Legal Frameworks and Scholarly Perspectives 

Different countries have differing legal frameworks to tackle the problem of increased national security concerns due to growing DeFi services and lack of regulatory mechanisms. The United States applied existing anti-money laundering and financial privacy laws to DeFi platforms with evolving interpretations through the Bank Secrecy Act (BSA) and FinCen Regulations. DeFi actors were subjected to reporting and compliance. In order to prevent the proliferation of digital currency, the Anti-CBDC Surveillance State Act was moved to safeguard privacy, indicating the growing tension between the need for surveillance for civil liberties and national security. This application of existing laws garnered criticisms from scholars such as Robert Chesney, who criticized the Supreme Court for introducing “confusions of doctrinal nature” into the state secrets law through its decision granting privilege to the government and their assertions in United States v. Abu Zubaydah. 

India has taken a cautious and security-focused regulatory stance. The reliance by regulators is placed on current financial and national security laws, including the Prevention of Money Laundering Act, 2002 (PMLA), the Information Technology Act, 2000, and regulatory oversight by the Reserve Bank of India (RBI) and the Financial Intelligence Unit–India (FIU-IND), rather than developing a comprehensive DeFi framework. 

In Internet and Mobile Association of India v. Reserve Bank of India, 2020, the court held that the circular by Reserve Bank was disproportionate and emphasised on the current regulatory landscape affecting the digital assets in India. Therefore, India has leveraged investment screening laws and national security legislation to oversee Fintech and DeFi related infrastructure and relies on a risk-based approach to prevent networks for terrorism. 

The Markets in Crypto-Assets Regulation by the EU provides a comprehensive legal regime for crypto-asset service providers with strong harmonised mechanisms to combat AML/CFT and to enhance transparency. The 2025, EU Anti-Money Laundering Package further strengthened the risk-based supervision of protocols and emphasised on cross-border cooperation. In the case of Kennedy v. United Kingdom, the European Court of Human Rights enforced tests pertaining to necessity and proportionality in national security so as to balance individual growth with state interests. 

In order to maintain global standards and international cooperation, an inter-governmental organisation, the Financial Action Task Force (FATF), was introduced, which provides laws and regulations to secure the international financial market from money laundering and illicit financial crimes and prohibits the manufacturing of weapons of mass destruction. The directives issued are comprehensive in nature, wherein the signatory countries take measures to curb the menace caused due the financing of terrorist activities. In June 2025, the FATF published its sixth update on the global implementation of countering the funding of terrorism standards for virtual assets and service providers as a continuation to ensure compliance by more jurisdictions. Academicians have emphasised the adoption of “liability strategy” through which imposition of post-hoc liability on DeFi actors would cause harm and allows the court-based litigation and dispute resolution mechanisms for damages rather than a blanket pre-emptive regime or ban.  

Recommendations for Legal and Policy Implications

Tiered Regulation and Licensing System- The conduct through DeFi services should be subjected to licensing system based on clear benchmarks for organisational centralisation, potential systematic impact and risk-mitigation measures. The specific licences and stricter compliance requirements must be introduced for the operators of lending pools, custodial protocols and stablecoins as these activities pose higher systemic risks and regulatory oversees which was highlighted in the 2025 Report by FATF, wherein it stated that around half of the advanced jurisdictions require DeFi arrangements to be treated as registered and licensed.

Regulatory Supervision-Regulators should develop technical frameworks for automated and direct scrutiny of DeFi transactions including provisions allowing regulatory “backdoors” without undermining data sovereignty and privacy. This could be done by employing “embedding supervision” pilot projects wherein the regulators would participate in the network and would monitor the flows in real time. 

Consumer Protection, Cyber-Security and Legal Accountability- As per the EU Digital Operational Resilience Act, Network and Information Systems Directive 2, the DeFi platforms must comply with supervisory and cybersecurity regulations such as multi-factor authentication, operational requirements and annual penetration risks along with strict imposition of rapid incident reporting obligations for all critical infrastructural and regulatory failures. The rights of the consumers would be ensured by developing standards which create distinct liabilities for developer teams and governance holders. The dispute resolution process must be specialised through blockchain based-arbitration wherein the rules should be based on functions and must be technologically literate.

 Conclusion: The Way Forward

On a conclusory note, the intersection of DeFi and national security is at the crossroads marked by uncertainty, growing enforcement challenges and increased financial innovation. Its emergence as a parallel and decentralised ecosystem has challenged the compliance and jurisdictional frameworks of traditional financial and legal regulators. The resultant jurisdictional and regulatory gaps have resulted in increased risk of illicit financial flows, terrorism financing and cyberattacks posing a serious threat on the national security and sovereignty of a nation. Despite the introduction of newer regional frameworks such as Financial Action Task Force, EU’s Market in Crypto-Assests Regulation and global standards from International Organisation of Securities Commissions (IOSCO) the existing approaches remain fragmented, failing to provide an adaptive and unified sectoral framework.