DeFi Regulation Clash Threatens U.S. Crypto Leadership

The U.S. Senate Democrats have introduced a contentious proposal to impose stringent regulations on decentralized finance (DeFi) protocols, sparking widespread criticism from industry experts and advocates who argue it could stifle innovation and undermine bipartisan efforts to establish a balanced regulatory framework. The proposal, part of the broader CLARITY Act, seeks to empower the Treasury Department to create a "restricted list" of DeFi protocols deemed excessively risky, effectively criminalizing their use. Critics describe the measure as an unconstitutional overreach that prioritizes centralized control over decentralized innovation .

Under the Democrats' counter-proposal, any individual deploying a DeFi protocol would be classified as an intermediary, stripping developers of protections previously negotiated in bipartisan drafts. This would expose developers to potential charges under the 1960 Unlicensed Money Transmitter Act, a move condemned as overly broad and punitive. The proposal also mandates Know Your Customer (KYC) requirements for front-end providers, regardless of whether developers have control over user data, and grants the Treasury broad discretion to ban protocols it deems risky . Jake Chervinsky, a prominent crypto lawyer, called the proposal an "unprecedented government takeover" of the DeFi industry, warning it could drive innovation offshore and create regulatory uncertainty .

The Democrats' stance directly clashes with the bipartisan Responsible Financial Innovation Act (RFIA) draft, which aims to assign the Commodity Futures Trading Commission (CFTC) oversight of spot markets and protect developers from overreach by the Securities and Exchange Commission (SEC). The RFIA, supported by Senate Banking Committee Chair Tim Scott, emphasizes a risk-based approach to regulation and seeks to foster innovation while addressing illicit finance. In contrast, the Democrats' proposal has stalled negotiations, with Republicans pausing further discussions until Democrats agree to schedule a markup session .

Industry stakeholders have uniformly criticized the proposal. The Digital Chamber's Zunera Mazhar argued that targeting DeFi with heavy-handed rules risks pushing innovation to more crypto-friendly jurisdictions. Meanwhile, Variant Fund's CLO Jake Chervinsky reiterated that the proposal "isn't just anti-crypto-it's anti-innovation," creating a dangerous precedent for tech sectors beyond finance . Summer Mersinger of the Blockchain Association added that the language is "impossible to comply with" and would effectively ban DeFi development in the U.S. .

Legislatively, the CLARITY Act, which includes the restricted list provision, faces an uncertain path. The House passed the Act in July 2025 with bipartisan support, but the Senate Banking Committee's RFIA draft offers an alternative framework that retains some SEC discretion over digital assets. The RFIA's focus on "ancillary assets" and its directive for the SEC to modernize regulations could diverge significantly from the CLARITY Act's CFTC-centric approach. Senate leaders aim to finalize market structure legislation by September 30, 2025, but the current impasse highlights deepening partisan divides .

The debate underscores broader tensions in U.S. crypto policy. While the Trump administration has championed pro-innovation policies, such as repealing the IRS's DeFi Broker Rule, the Democrats' proposal reflects concerns over consumer protection and systemic risks. However, critics argue that the restricted list approach is a blunt instrument that fails to address real risks while stifling growth. The outcome of these negotiations will likely shape the U.S.'s position in the global crypto landscape, determining whether it remains a hub for innovation or cedes ground to more favorable jurisdictions .