Democrats' DeFi 'Restricted List' Criticized as Effective Crypto Ban

Democrats Propose 'Restricted List' for DeFi Protocols, Sparking Outcry

A group of Democratic Senators has introduced a controversial counter-proposal to impose stringent regulatory measures on decentralized finance (DeFi) protocols, including the creation of a "restricted list" for protocols deemed too risky. The proposal, outlined in a letter to the Senate Banking Committee, seeks to mandate Know Your Customer (KYC) rules for crypto app frontends and non-custodial wallets while removing protections for developers. Critics argue the move risks stifling innovation and could effectively "ban crypto" by criminalizing the use of targeted DeFi protocols.

The proposal emerged as a response to the Senate Banking Committee's bipartisan Responsible Financial Innovation Act (RFIA), which aims to streamline regulatory oversight of crypto markets. The Democrats' counter-proposal clashes with RFIA's provisions, which assign the Commodity Futures Trading Commission (CFTC) oversight of spot markets and limit the Securities and Exchange Commission's (SEC) reach. The RFIA also seeks to shield developers from prosecution, a move intended to address recent legal challenges faced by projects like Tornado Cash and Samourai Wallet.

Central to the Democrats' plan is the Treasury Department's authority to establish a "restricted list" of DeFi protocols, with users facing criminal liability for engaging with them. Jake Chervinsky, a crypto lawyer, criticized the proposal as an "unprecedented, unconstitutional government takeover" that undermines the bipartisan support for the CLARITY Act, which passed in the House in July with 294 votes. "This isn't regulation-it's a ban," he stated, emphasizing the proposal's potential to derail broader regulatory efforts and deter innovation.

The initiative has drawn sharp criticism from industry advocates. Zunera Mazhar, vice president of policy at the Digital Chamber, described the measures as "heavy-handed and ineffective," warning that they could push innovation offshore rather than address illicit finance risks. She argued for a risk-based approach targeting "real chokepoints" in the financial system rather than penalizing decentralization.

The proposal also faces scrutiny for its timing. It arrives amid a government shutdown and risks reversing regulatory momentum under the Trump administration, which has positioned the U.S. as a global "crypto capital." The counter-proposal's focus on KYC requirements for non-custodial wallets-tools designed to avoid centralized control-highlights a fundamental tension between regulatory goals and the decentralized ethos of DeFi.

Supporters of the Democrats' plan argue it addresses legitimate concerns about illicit finance and consumer protection. However, opponents counter that it prioritizes overreach over nuance, with the restricted list mechanism lacking clear criteria for protocol evaluation. This ambiguity raises concerns about arbitrary enforcement and regulatory uncertainty, which could deter investment and development in the sector.

The debate underscores a broader divide in U.S. crypto policy. While the Trump administration has championed innovation-friendly frameworks like the GENIUS Act, the Democratic proposal reflects a more cautious, risk-averse approach. This divergence complicates efforts to craft a cohesive regulatory strategy, particularly as the EU advances its Markets in Crypto-Assets (MiCA) framework, which balances innovation with systemic safeguards.

As the Senate navigates these competing priorities, the outcome could shape the future of DeFi and digital asset markets. For now, the proposal remains a work in progress, with critics urging lawmakers to revisit the approach to ensure it aligns with both regulatory objectives and the principles of technological innovation.

Source: [8] Democrats propose 'restricted list' for DeFi protocols, sparking outcry (https://cointelegraph.com/news/democrat-defi-regulation-proposal-restricted-list-critcs)

[9] Democrats propose 'restricted list' for DeFi protocols, sparking outcry (https://www.tradingview.com/news/cointelegraph:2bd5404eb094b:0-democrats-propose-restricted-list-for-defi-protocols-sparking-outcry/)