How to regulate DeFi?
The crypto industry has long been seeking a balance between user privacy needs and anti-money laundering (AML) and KYC requirements of regulators.
However, the decentralized nature of DeFi makes regulation extremely challenging. If a network is created by many people but is not controlled by any single entity, who should the government put pressure on? Raman pointed out: "Decentralized protocols have no central controller, so they cannot file 1099 forms (tax reporting forms) or fulfill broker-dealer responsibilities like traditional financial institutions. Although companies can operate as brokers, DeFi software itself is not designed for traditional compliance rules." Although DeFi developers can proactively cooperate with regulators, they still face many difficulties in actual operation. For example, after the $285 million KuCoin hack, some protocols chose to freeze the stolen funds to cooperate with law enforcement investigations. However, this approach is not a substitute for a comprehensive regulatory framework.
On March 12, the U.S. House of Representatives voted to repeal the IRS's crypto tax rule, which requires DeFi protocols to report all crypto transaction gross income and taxpayer information to the Internal Revenue Service (IRS).
The regulation was enacted by the IRS in December 2024 and was originally scheduled to take effect in 2027, but the crypto industry generally believes that its regulatory burden is too heavy and beyond the IRS's authority.
The White House has expressed support for the bill to repeal the rule, and President Trump is ready to sign it into law after it is delivered.
However, many DeFi observers pointed out that although this vote is a victory for the industry, DeFi has not yet found the best balance between privacy and compliance.
Adam Cochran, partner and consultant at Cinneamhain Ventures believes that although DeFi protocols can cooperate with law enforcement agencies through specific means, this does not mean that the market has a complete regulatory framework, and regulators still need to formulate clearer rules.
However, these specific examples do not constitute a comprehensive regulatory framework that the industry and investor protection agencies can follow.
In this regard, crypto analytics firm Chainalysis said in 2020 that regulators may need to take into account the limitations of decentralized reporting when formulating regulations in the DeFi field.
Raman suggested that a possible solution could be zero-knowledge proofs, which allow users to confirm certain data without revealing it.
He is optimistic about regulators’ ability to find a way to regulate the space while maintaining user privacy: “I think we’re going to see a positive-sum environment where DeFi and compliance coexist.”
Long-awaited regulatory framework for crypto
Trump has led parts of his administration to take a number of pro-crypto steps through executive orders and by appointing pro-crypto individuals — most recently the creation of a strategic Bitcoin reserve.
Support for cryptocurrencies by key financial regulators such as the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) has seen the withdrawal of multiple high-profile enforcement cases against cryptocurrency companies.
It is worth noting that the big fish that the crypto industry is waiting for is the crypto regulatory framework and stablecoin bill that is circulating in Congress, which will provide the industry with the guardrails it claims to need to thrive.
On March 13, the Senate Banking Committee approved the stablecoin bill "GENIUS Act", which is one step closer to a Senate vote.
The crypto framework bill FIT 21 was originally proposed in the 2024 legislative session and ultimately failed in the Senate. However, in February, French Hill, chairman of the House Financial Services Committee, said he expected the bill could pass “with modest modifications” this session.
But even if FIT 21 is passed soon, regulation of DeFi may still be a long way off. The bill would exclude DeFi from SEC and CFTC regulation, but would also establish a working group to study 12 key areas related to DeFi.
This study will seek to understand the risks and benefits of DeFi and ultimately make regulatory recommendations.
