Senate Crypto Split: DeFi Regulation Deadlock Threatens U.S. Innovation Lead

Senate Democrats have proposed a regulatory framework that would empower the Treasury Department to place DeFi protocols on a "restricted list" deemed too risky, sparking immediate backlash from industry leaders and halting bipartisan negotiations on crypto legislation. The proposal, unveiled on October 9, 2025, mandates Know Your Customer (KYC) rules for crypto app frontends-including non-custodial wallets-and removes legal protections for developers. Critics argue it effectively bans DeFi rather than regulates it, with potential penalties for U.S. users who engage with restricted protocols and derive recurring revenue from them Democrats Propose 'Restricted List' for DeFi Protocols in Bill That ...^[1].

The counter-proposal has been met with swift criticism. GOP negotiators suspended talks, calling the plan "incoherent" and "not written in legislative text," while crypto lawyer Jake Chervinsky labeled it an "unprecedented, unconstitutional government takeover of an entire industry" Democrats Propose 'Restricted List' for DeFi Protocols in Bill That ...^[1]. The move undermines the bipartisan Responsible Financial Innovation Act (RFIA) draft, which sought to assign the Commodity Futures Trading Commission (CFTC) oversight of spot markets and protect DeFi developers from prosecution following cases like Tornado Cash .

Industry stakeholders warn the proposal could force innovation overseas. Blockchain Association CEO Summer Mersinger stated the rules would "make compliance impossible," pushing development to jurisdictions with clearer frameworks. Coinbase CEO Brian Armstrong echoed these concerns, calling the plan "a bad proposal, plain and simple" that would "prevent the U.S. from becoming the crypto capital of the world" Democrats Propose 'Restricted List' for DeFi Protocols in Bill That ...^[1]. Digital Chamber's Zunera Mazhar criticized the Treasury's "sweeping authority" and narrow definition of decentralization, advocating for risk-based oversight aligned with global standards Democrats Implement Counter-Measure to Restrict DeFi Protocols^[2].

The political rift deepened as Republicans accused Democrats of delivering an incomplete proposal and leaking it to provoke controversy. Senate Banking Committee staff director Catherine Fuchs stated talks would pause "until we have an agreed upon date for markup," while Democratic negotiator Ruben Gallego's team defended their readiness to work but accused GOP colleagues of "crashing out" of negotiations . Senate Banking Chair Tim Scott's office emphasized repeated requests for substantive feedback since June 27, underscoring the lack of progress.

The proposal also faces internal Democratic divisions. Pro-crypto lawmakers like Gallego and Mark Warner clash with anti-crypto figures such as Elizabeth Warren, who has long warned of crypto's risks to financial stability. Warren's recent criticism of the SEC's handling of crypto cases further highlights the party's ideological split .

With the GOP-led RFIA effort stalled, the future of U.S. crypto legislation remains uncertain. Proponents of the RFIA draft argue it balances innovation with consumer protection, while the Democratic proposal risks stifling DeFi entirely. As industry leaders and lawmakers debate the path forward, the outcome could determine whether the U.S. retains its leadership in financial innovation or cedes ground to global competitors .