Senate Proposes DeFi "Ban" as Critics Warn of Innovation Exodus

Democrats in the U.S. Senate have sparked controversy by proposing a "restricted list" for decentralized finance (DeFi) protocols, a move critics argue could "kill DeFi" by criminalizing the use of platforms deemed too risky. The proposal, introduced by a group of Democratic senators, seeks to impose Know Your Customer (KYC) rules on non-custodial crypto apps and strip protections for developers, according to a report from the Senate Banking Committee Democrats. Jake Chervinsky, a prominent crypto lawyer, criticized the plan as an "unprecedented, unconstitutional government takeover of an entire industry," arguing it undermines bipartisan efforts to establish a regulatory framework, such as the CLARITY Act passed in the House. The restricted list would empower the Treasury Department to ban DeFi protocols it deems high-risk, a measure Chervinsky called a "ban on crypto" rather than regulation.

The proposal clashes with the Senate Banking Committee's bipartisan Responsible Financial Innovation Act (RFIA) draft, which aims to assign the Commodity Futures Trading Commission (CFTC) oversight of spot markets and protect crypto developers from overreach by the Securities and Exchange Commission (SEC). The RFIA, released in September 2025, includes provisions to exempt non-fungible tokens (NFTs) and decentralized physical infrastructure networks (DePINs) from securities regulations and establish a regulatory "sandbox" for innovation. However, the Democratic counter-proposal threatens to derail these efforts by prioritizing heavy-handed restrictions over a balanced approach. The RFIA also emphasizes a risk-based strategy to combat illicit finance without stifling innovation, a stance echoed by the Digital Chamber, which warned that punishing decentralization could push innovation offshore.

Industry stakeholders have condemned the restricted list as impractical and counterproductive. Zunera Mazhar, vice president of the Digital Chamber, argued that targeting DeFi protocols ignores the "real chokepoints" of illicit finance and creates regulatory uncertainty. She emphasized that effective policy should focus on consumer protection and innovation preservation rather than imposing blanket bans. Similarly, Chervinsky highlighted the proposal's constitutional flaws, noting it could set a dangerous precedent for government control over emerging technologies. Critics also raised concerns about the broader implications for the tech sector, with some suggesting the move reflects a reversal of regulatory momentum built under the Trump administration, which aimed to position the U.S. as the "crypto capital of the world".

The debate underscores a growing divide within Congress over DeFi regulation. While the RFIA seeks to harmonize oversight and foster growth, the Democratic proposal represents a more adversarial approach. This tension has drawn attention from labor groups, with the AFL-CIO recently opposing the RFIA on the grounds that it could expose retirement funds to crypto volatility. However, the restricted list proposal appears to exacerb these concerns by directly targeting DeFi protocols, a sector already grappling with regulatory ambiguity. The outcome of this legislative tug-of-war could shape the trajectory of DeFi in the U.S., determining whether the country remains a leader in digital asset innovation or cedes ground to more accommodating jurisdictions.

As the debate unfolds, industry players and lawmakers remain divided on the best path forward. While proponents of the restricted list argue it is necessary to mitigate risks, opponents stress that overregulation could stifle the very innovation the sector promises to deliver. With the U.S. crypto landscape at a crossroads, the final form of DeFi regulation may hinge on finding a balance between consumer protection, market stability, and the preservation of decentralized technologies.

Source: [1] Cointelegraph (https://cointelegraph.com/news/democrat-defi-regulation-proposal-restricted-list-critcs) [4] DWT (https://www.dwt.com/blogs/financial-services-law-advisor/2025/09/senate-responsible-financial-innovation-act-draft)