Senate's DeFi Rules Spark Fears of Innovation Exodus and Regulatory Overreach

The U.S. Congress faces a deepening impasse over a Senate Democratic proposal to regulate decentralized finance (DeFi) platforms, sparking industry backlash and stalling bipartisan efforts to establish a crypto market structure. The proposal, which would empower the Treasury Department to create a "restricted list" of DeFi protocols deemed too risky, has drawn sharp criticism from crypto advocates, legal experts, and Republican lawmakers as a de facto ban on decentralized innovation. The draft, circulated by Senate Banking Committee Democrats on October 9, 2025, mandates Know Your Customer (KYC) compliance for non-custodial wallets and front-end services, effectively classifying DeFi developers as financial intermediaries Senate Democrats Propose 'Restricted List' for DeFi Protocols in Bill That Could Kill Sector^[1].

The proposal's immediate consequence was the suspension of GOP-led negotiations on a market structure bill, with Senate Banking Committee Republican Staff Director Catherine Fuchs stating talks would pause "until we have an agreed-upon date for markup" Senate Democrats Propose 'Restricted List' for DeFi Protocols in Bill That Could Kill Sector^[1]. Republicans condemned the draft as incoherent and lacking legislative substance, accusing Democrats of undermining bipartisan progress. Senate Banking Chair Tim Scott, who had aimed to pass a market structure bill by year-end, now faces uncertainty as the House's CLARITY Act-passed in July with bipartisan support-remains unaligned with Senate efforts Senate Democrats Propose 'Restricted List' for DeFi Protocols in Bill That Could Kill Sector^[1].

Industry leaders, including Blockchain Association CEO Summer Mersinger and Coinbase CEO Brian Armstrong, warned the proposal would force DeFi innovation offshore, where compliance with U.S. regulations would be impractical. Mersinger stated the draft's language was "impossible to comply with" and would "drive responsible development overseas," while Armstrong called it a move to "set innovation back" and prevent the U.S. from becoming the "crypto capital of the world" Senate Democrats Propose 'Restricted List' for DeFi Protocols in Bill That Could Kill Sector^[1]. Similar concerns were echoed by the Digital Chamber's Zunera Mazhar, who criticized the proposal for using "outdated tools" and urged a risk-based approach to address illicit finance without stifling innovation Senate Democrats Propose 'Restricted List' for DeFi Protocols in Bill That Could Kill Sector^[1].

The Senate Democrats' counter-proposal clashes with the bipartisan Responsible Financial Innovation Act (RFIA), introduced in September. The RFIA sought to assign the Commodity Futures Trading Commission (CFTC) oversight of spot markets while protecting DeFi developers from prosecution, as seen in cases involving Tornado Cash and Samourai Wallet. Critics argue the Democratic draft undermines these protections by imposing sweeping compliance obligations on front-end services, effectively treating them as financial intermediaries Senate Democrats Propose 'Restricted List' for DeFi Protocols in Bill That Could Kill Sector^[1].

Legal experts, including Variant Fund's Jake Chervinsky, labeled the proposal "unconstitutional" and a "government takeover of an entire industry," warning it would eliminate opportunities to establish a structured crypto framework. Chervinsky noted the proposal's potential to weaken the CLARITY Act's bipartisan support in the House, where it passed 294–134 in July Senate Democrats Propose 'Restricted List' for DeFi Protocols in Bill That Could Kill Sector^[1].

The stalemate has also drawn attention to broader debates over regulatory jurisdiction. The Senate Agriculture Committee, which oversees the CFTC, has yet to release its version of the market structure bill, further complicating reconciliation with the House's framework. Meanwhile, the AFL-CIO has joined the fray, urging the Senate Banking Committee to oppose the RFIA, citing risks to workers' retirement funds from crypto volatility Senate Democrats Propose 'Restricted List' for DeFi Protocols in Bill That Could Kill Sector^[1].

As the political standoff intensifies, the crypto industry remains in limbo. With the government shutdown extending into its second week, progress on the market structure bill has slowed, raising concerns that delays could push legislative action to 2026. Senator Cynthia Lummis, a key advocate for crypto-friendly policies, emphasized the urgency of passing stablecoin regulations but acknowledged political divisions and Trump-era conflicts of interest as significant hurdles Crypto Regulation Delays Could Push U.S. Bills to 2026^[12].