DeFi Regulation: Senate Votes to repeal IRS Rule
On March 4, the U.S.Senate voted 70-27 to repeal an IRS rule that would have imposed traditional financial reporting on decentralized exchanges and defi protocols. This bipartisan move aims to protect financial privacy and innovation in the crypto space.
The repealed rule would have forced DeFi platforms to report crypto transactions,treating them like conventional financial intermediaries. This could have been disastrous, as DeFi platforms don’t hold user funds or function as intermediaries. The resolution now moves to the House and then to President Trump, who is highly likely to support it.
Crypto advocates see this as a win, but regulatory uncertainty remains. To understand the implications, we spoke with Hedi Navazan, Chief Compliance officer at 1inch.
The IRS rule, introduced under Biden, aimed to address the $50 billion annual tax gap from unreported crypto trades. However,it faced opposition due to its misunderstanding of DeFi’s structure.Navazan argues that DeFi protocols don’t custody user assets, making traditional broker-like regulations infeasible. DeFi relies on self-executing smart contracts, not managed accounts. Forcing DeFi to act as brokers would be like demanding open-source protocols collect user data they don’t have. The rule was part of a broader push for tax compliance. The Treasury projected it could recover $3.9 billion in lost revenue. But DeFi’s design makes compliance nearly impractical. DeFi platforms don’t hold user funds, making traditional reporting requirements technically infeasible.
Navazan says, “This proposal reflects a misguided rush to regulate without understanding the technology. Many DeFi protocols don’t hold user funds, making such regulations technically infeasible.”
Navazan believes regulatory focus should be on security practices. In 2023, hackers stole over $1.8 billion from DeFi platforms. navazan suggests prioritizing smart contract security and protecting users from exploits. Excessive regulation could drive DeFi underground, much like centralized exchanges.
Navazan states, “Regulators should focus on setting standards for smart contract security and identifying malicious tokens. The attention is disproportionately focused on taxation, while hackers continue to steal assets.”
Navazan adds, “Regulatory efforts should prioritize security practices and governance frameworks for decentralized autonomous organizations.”
Navazan warns, “Heavy-handed policies could drive defi activity out of the U.S. The battle over DeFi’s legal status is far from over.The rule would have required developers to report tax data they don’t have access to. The rule would have been akin to demanding open-source protocols collect user facts they weren’t designed to handle. The rule would have required software developers to report data they can’t access. The rule would have treated DeFi like centralized exchanges,which is technically infeasible. The rule would have required developers to report tax data they don’t have. The rule would have treated DeFi like centralized exchanges, which is technically infeasible.”
Navazan believes, “Regulatory focus should be on setting standards for smart contract security and protecting users from exploits. The rule would have required developers to report data they don’t have. DeFi’s future depends on a coherent governance framework and proper security guidance.”
Navazan concludes, “Regulatory focus should be on setting standards for smart contract security and
DeFi Regulation: Balancing Innovation and Compliance
Overregulation in DeFi could push innovation out of the U.S. Many crypto firms are relocating to friendlier jurisdictions like Dubai and Switzerland. This trend started in 2023 when Coinbase and Gemini considered moving overseas due to regulatory uncertainty.
DeFi protocols, lacking physical headquarters, are also shifting their teams to more favorable locations. Aggressive regulation could lead to the rise of crypto privacy tools, complicating tax enforcement. The U.S. Treasury’s sanctions on tornado Cash didn’t stop demand for anonymous transactions; it just pushed users to other platforms.
Without clear regulations,institutions are hesitant to engage with DeFi. However,interest is growing,with projects like JPMorgan’s ONYX exploring tokenized assets. High-yield opportunities in DeFi attract investors, but excessive regulation could lead to tax evasion.
Regulators need a balanced approach. Rather of forcing centralized reporting, they should focus on blockchain-native compliance solutions. On-chain analytics tools, like those from Chainalysis and Elliptic, can help monitor transactions without burdening DeFi platforms.
Permissioned DeFi, where vetted liquidity pools meet compliance standards, is another solution. This model allows for oversight while preserving decentralization. Policymakers should explore these blockchain-native mechanisms to effectively regulate DeFi.
U.S. Crypto Regulation: A Cycle of uncertainty
The U.S. crypto policy is stuck in a political cycle, making it hard for businesses to plan. Each new governance brings changes, leaving the industry unsure. this instability is a big problem for crypto companies, investors, and developers.
Navazan, an expert, says this lack of consistency is a major barrier. Without a stable framework, it’s tough for big players to adopt DeFi. In contrast, Europe has a unified approach with the Markets in Crypto-Assets regulation. It offers clear rules across the region, unlike the U.S., where rules can change every few years.
Navazan points out that the U.S. lacks a long-term strategy. The EU’s approach is more stable, allowing businesses to operate smoothly. The U.S. has no single rulebook. Instead, it has a fragmented system with agencies like the SEC, CFTC, and IRS enforcing different rules. This disjointed approach threatens U.S. leadership in digital assets.
- EU has a unified legal framework.
- U.S.lacks a stable framework.
- EU has a unified legal framework.
The upcoming White House Crypto Summit on march 7 could be key. It may gather leaders like Michael Saylor and Brian Armstrong. Their discussions could shape the future of U.S. crypto regulation.
Will this summit lead to progress or just another political move? The outcome will decide if the U.S. leads in digital finance or falls behind. A tiered regulatory approach could help. It would focus on areas that interact with traditional finance, like stablecoins, while letting decentralized protocols operate freely.
Navazan believes a stable policy is crucial. Without it, innovation might move elsewhere. The summit could influence the next phase of U.S. crypto rules. The event might determine if the U.S. stays ahead in digital finance.
