Elliptic and Zama Bring AML Screening to Confidential DeFi: What Accounting Firms and CFOs Must Assess Now
Blockchain analytics firm Elliptic has announced a partnership with Zama, a confidentiality protocol for on-chain finance, to provide wallet risk screening for confidential financial applications. The collaboration directly addresses the tension that has so far limited institutional adoption of public blockchain infrastructure: how do you protect sensitive financial data on a transparent network while still meeting the AML and compliance controls that regulated markets require? For accounting firms, auditors, and CFOs who advise or service clients operating in the digital asset space, this development has direct implications for how compliance workflows are designed and how crypto accounting software must evolve to handle encrypted on-chain positions.
What Zama's Confidential Finance Technology Does
Zama describes itself as a confidentiality protocol for on-chain finance and claims the fastest-growing position in that category. Its core technology is Fully Homomorphic Encryption (FHE), a cryptographic technique that allows computation to be performed on encrypted data without first decrypting it. In a DeFi context, this means token balances and transaction amounts can remain encrypted even while the underlying network remains public and auditable.
Why Standard DeFi Creates an Institutional Problem
In conventional DeFi protocols, every wallet balance and every transaction amount is visible to any observer with access to the public blockchain. That transparency is structurally incompatible with how financial institutions handle client data. A fund manager, a corporate treasury, or a lending desk cannot broadcast its positions to competitors and counterparties simply because it chose to operate on a public chain. FHE resolves this by encrypting only the sensitive variables, specifically the amounts and balances, while leaving the network itself open and auditable. The institution retains the auditability that regulators expect, and its counterparties cannot read its book.
The First Live Application: Confidential USDC Yield Vaults
Zama's first production use case involves a confidential DeFi vault built in collaboration with Morpho and Steakhouse Financial. Users convert USDC into a confidential variant called cUSDC through the Zama application, then deposit that cUSDC into the Steakhouse Confidential Prime USDC vault on the Morpho protocol to earn yield. At no point are the user's balance or position size exposed on chain. The vault has attracted institutional interest, though Zama has not published specific figures on assets under management in the source announcement.
How Elliptic's Wallet Screening Integrates Without Breaking Confidentiality
The practical question compliance teams will ask is straightforward: if the balances and amounts are encrypted, how can a screening provider perform any meaningful AML check? Elliptic's approach is to operate at the wallet identity layer rather than the transaction-value layer. The firm screens the wallet address itself for risk signals, checking it against its blockchain intelligence database before the user enters a confidential financial application. Elliptic explicitly states it does not require access to encrypted balances, transaction amounts, or any other confidential financial information from end users.
Risk-Based Controls Before the Entry Point
Where Elliptic's screening identifies a wallet as high risk, institutions can apply appropriate compliance controls before that wallet gains access to the confidential application. This is structurally similar to a gated onboarding flow in traditional finance: the check happens at the door, not inside the vault. The encrypted activity inside the protocol remains confidential; the compliance control sits upstream of it. Jackson Hull, CTO and COO at Elliptic, framed the model clearly in the announcement: screening wallets for risk before a transaction proceeds is the mechanism by which confidential finance can meet the standards regulated markets expect.
What This Means for Compliance Programme Design
For compliance officers and the accounting firms that advise them, the Elliptic-Zama model establishes a precedent worth tracking. It demonstrates that the AML obligation, specifically the requirement to screen for sanctions exposure and illicit-finance risk before onboarding a customer or processing a transaction, can be discharged at the wallet level without the screening provider ever touching the encrypted financial data. That is not a trivial architectural point. It suggests that the binary choice institutions have historically faced, either full on-chain transparency or no compliance, is not the only option.
Regulatory and AML Context for Accounting Firms and CFOs
The timing of this development sits against an active global regulatory backdrop. FATF's position on DeFi, outlined in its guidance on centralised elements within DeFi protocols, is that where a protocol has identifiable controlling parties, those parties carry VASP-equivalent obligations including AML and KYC requirements. Zama and Morpho both have identifiable teams and governance structures, which means the wallet-screening layer Elliptic provides is not just commercially sensible but arguably responsive to where the regulatory trajectory is heading. Accounting firms advising clients who operate or invest in DeFi protocols should review our analysis of FATF guidance on DeFi and centralised elements as VASPs alongside this development.
Sanctions Screening Remains Non-Negotiable
FHE does not create a sanctions carve-out. A wallet controlled by a sanctioned person or entity does not become permissible simply because the transaction amounts are encrypted. The Elliptic-Zama integration is specifically designed to address this: wallet-level screening for sanctions and illicit-finance risk happens before any confidential transaction is initiated. For CFOs and compliance leads at firms with exposure to DeFi protocols, the question to ask of any confidential finance product is whether it has an equivalent pre-entry screening mechanism, and whether that mechanism is connected to a sanctions list that is updated in real time.
Travel Rule Implications
The FATF Travel Rule requires VASPs to pass originator and beneficiary information alongside transfers above a threshold. Confidential DeFi creates a structural question about how that obligation is met when transaction amounts are encrypted at the protocol layer. The Elliptic-Zama model does not resolve the Travel Rule question directly, as wallet screening is not the same as passing Travel Rule data. This remains an open compliance architecture problem that accounting firms should flag when advising clients building on confidential finance infrastructure. The broader VASP compliance picture is covered in our summary of the FATF VASP targeted update from July 2026.
Accounting and Audit Implications
Recognising and Measuring cUSDC Positions
When a client holds cUSDC in a Morpho vault, the accounting question is whether that position is substantively different from holding plain USDC in a DeFi protocol. Under both IFRS and US GAAP, the recognition and measurement of a crypto asset is driven by the nature of the asset and the rights it confers, not by whether its on-chain representation is encrypted. cUSDC is a wrapped token representing a claim on USDC held in a confidential vault. Auditors should confirm the redemption mechanics, verify that the peg to USDC holds under the smart contract terms, and obtain evidence of the vault balance from a source other than the encrypted on-chain state, such as the protocol's own reporting interface or a third-party attestation.
Evidence of Existence When Balances Are Encrypted
Encryption at the protocol layer creates a practical audit evidence challenge. If a client's cUSDC balance is not readable from the public blockchain by a third-party observer, the auditor cannot use a standard blockchain explorer to confirm existence independently. Firms will need to work with clients to obtain direct evidence: wallet private key confirmation of the encrypted balance via a secure process, or a signed attestation from the protocol operator. This is not unprecedented; it mirrors the process for auditing assets held in custody arrangements where the custodian holds information the auditor cannot access directly. Crypto bookkeeping software used by accounting firms will need to support the import and reconciliation of encrypted-balance positions, either through protocol APIs or manual attestation workflows, to keep client records complete.
Yield Accrual and Tax Timing
Yield earned in a confidential vault accrues in the same way as yield in any other DeFi protocol from a tax perspective. The confidentiality of the on-chain record does not affect the taxable event; in most jurisdictions, yield from DeFi activity is taxable as ordinary income or capital gain depending on the characterisation applied by the relevant authority. The challenge is that clients may not have a clear record of the yield accrued per period if their digital asset accounting software cannot read encrypted positions. Firms should establish a process for clients to export yield data from the Zama application interface at each reporting period and reconcile it against the cost basis records held off-chain.
What to Watch as Confidential Finance Scales
Rand Hindi, CEO and co-founder of Zama, stated in the announcement that financial institutions should not have to choose between protecting sensitive financial information and meeting compliance obligations. That framing reflects a maturing institutional narrative around confidential finance: the technology is being designed with compliance in scope from the outset rather than retrofitted after the fact. For accounting firms and CFOs, the practical implication is that confidential finance is moving from a theoretical construct toward a deployable product category, and the compliance, audit, and tax workflows that serve it need to be in place before client exposure scales.
Key developments to monitor include: how regulators, particularly in the EU under MiCA and in the US under any forthcoming digital asset framework, address the auditability requirements for confidential finance protocols; whether FHE-based products attract specific guidance from standard-setters on audit evidence; and how the Travel Rule obligation is resolved at the protocol level as confidential DeFi expands to more asset types and transaction patterns.
Frequently Asked Questions
Does FHE encryption make a DeFi protocol exempt from AML obligations?
No. Encryption at the transaction-value layer does not change the AML obligations of the parties operating or controlling a protocol. Where a protocol has identifiable governing parties, FATF's framework treats those parties as having VASP-equivalent obligations, including customer due diligence and sanctions screening. The Elliptic-Zama integration addresses this by placing wallet-level risk screening before any user enters the confidential application.
How does an auditor verify a client's encrypted DeFi balance?
Standard blockchain explorer tools will not display an encrypted balance. Auditors will need to obtain evidence through alternative means: a controlled wallet-level query that decrypts the balance in a secure environment, a signed balance attestation from the protocol operator, or an API export from the application interface. The approach mirrors custodian confirmation processes already used in traditional finance.
Is yield earned in a confidential vault taxable?
Yes, in virtually all jurisdictions that have issued guidance on DeFi yield. The confidentiality of the on-chain record does not affect the taxable nature of the income. Clients need to export yield data from the application interface at each reporting period and ensure it is reconciled with their tax records.
What is cUSDC and how should it be classified on a balance sheet?
cUSDC is a wrapped token representing a claim on USDC held in Zama's confidential vault. For accounting purposes, the key questions are whether the redemption right is unconditional, whether the peg to USDC is contractually maintained, and whether the holder retains control of the underlying asset. Under both IFRS and US GAAP, classification will depend on those substantive rights rather than on the encrypted on-chain representation.
Does the Elliptic-Zama model resolve the FATF Travel Rule for confidential transactions?
Not fully. Wallet-level screening for risk and sanctions satisfies the pre-entry due diligence requirement but does not constitute the transmission of originator and beneficiary information required under the Travel Rule for transfers above the applicable threshold. How confidential finance protocols will satisfy the Travel Rule at the transaction layer remains an open compliance architecture question.
Source: Elliptic