Could DeFi survive under outdated financial regulations? Experts suggest that forcing decentralized platforms into compliance models designed for banks would have been disastrous, proving why policymakers must rethink their approach.
Table of Contents
Senate votes to repeal IRS rule
The U.S. government’s long-running tension with decentralized finance has reached another crucial moment.
On Mar. 4, in a rare display of bipartisan agreement, the Senate overwhelmingly voted 70–27 to repeal an IRS rule that would have imposed traditional financial reporting requirements on decentralized exchanges and DeFi protocols.
Had it taken effect, the rule would have forced developers and DeFi platforms to report crypto transactions to the IRS, effectively treating them like conventional financial intermediaries.
The resolution now heads to the House for another vote before landing on President Donald Trump’s desk. With Trump’s AI and crypto czar, David Sacks, already signalling support for the repeal, the measure appears to be on a fast track to becoming law.
Crypto advocates see this as a major win for financial privacy and innovation, but with the House vote still pending and regulatory uncertainty lingering, the battle over DeFi’s legal status is far from over.
To explore the implications, crypto.news spoke exclusively with Hedi Navazan, Chief Compliance Officer at 1inch (1INCH), one of the most prominent DeFi aggregators in the space.
The IRS rule and its repeal
The IRS’s now-repealed rule sought to impose traditional financial reporting obligations on DeFi protocols, effectively classifying them as brokers.
Under this requirement, decentralized platforms would have been forced to report gross proceeds and user transaction details — even though they do not hold user funds or function as financial intermediaries.
Introduced under the Biden administration as part of a broader push for tax compliance in the crypto sector, the rule was designed as one of the measures to address the estimated annual tax gap attributed to unreported crypto transactions.
According to a 2022 analysis by Barclays, the gap between the taxes the IRS collects and what it is owed from crypto trades could amount to as much as $50 billion annually.
The Treasury Department projected that by expanding the definition of brokers, the government could recover $3.9 billion in lost revenue over the next decade.
However, the proposal faced fierce opposition, as DeFi’s structural design made compliance nearly impossible. Navazan argues that the IRS fundamentally misunderstood how DeFi operates.
“This proposal reflects a misguided rush to regulate without a clear understanding of the technological complexities involved. It overlooks the fact that many decentralized finance protocols, including decentralized exchange aggregators, do not custody user assets, which makes the concept of applying traditional broker-like regulations technically infeasible.”
One of the biggest concerns raised by industry leaders was that the rule would have required software developers and smart contract creators to report tax data they had no access to.
Unlike centralized exchanges such as Coinbase or Binance, DeFi platforms rely on self-executing smart contracts running on public blockchains, meaning there is no company managing user accounts or holding customer funds.
Forcing them to act as brokers would have been akin to demanding that an open-source protocol collect and store user information it was never designed to handle.
While tax compliance has been a key focus for regulators, security remains one of DeFi’s most pressing issues. In 2023 alone, hackers stole over $1.8 billion from DeFi platforms, with high-profile breaches affecting Euler Finance, Atomic Wallet, and Curve Finance.
Navazan believes that regulatory efforts should prioritize these vulnerabilities instead of fixating on taxation.
“What is more pressing for DeFi’s future is the development of a coherent governance framework for decentralized autonomous organizations and proper guidance on security practices. Regulatory focus should be on setting standards for smart contract security, identifying malicious tokens, and protecting users from exploits. Unfortunately, there is a significant gap in regulatory oversight in these critical areas, and while hackers continue to steal assets and malicious tokens proliferate, the attention seems to be disproportionately focused on taxation.”
The economic fallout – driving DeFi underground?
A growing concern among industry leaders is that excessive regulation could drive DeFi activity out of the U.S., much like what has already happened with centralized exchanges.
Navazan warns that heavy-handed or ambiguous policies do not promote compliance — they simply force innovation to leave.
“Forcing centralized financial regulations onto DeFi could have unintended consequences, including driving crypto transactions underground or to offshore jurisdictions. One major risk is that excessive regulatory burdens will push DeFi innovation out of the U.S., similar to what has already been observed with many crypto companies relocating to jurisdictions like Dubai, Switzerland, and Liechtenstein.”
The industry has already seen high-profile exits. In 2023, Coinbase, the largest U.S.-based crypto exchange, announced that it was considering shifting its headquarters overseas due to regulatory uncertainty. Gemini followed suit, in response to the lack of a clear U.S. framework.
Even DeFi protocols — despite having no physical headquarters — are beginning to move their development teams and legal entities to more favorable jurisdictions.
Another unintended consequence of aggressive regulation is the rise of crypto privacy tools that could make tax enforcement even more difficult.
The U.S. Treasury’s sanctions on Tornado Cash (TORN), a privacy protocol, did not eliminate demand for anonymous transactions — it simply pushed users toward alternative platforms. Since the ban, new privacy-focused DeFi protocols have emerged, many of which are now being built beyond U.S. regulatory reach.
Navazan believes that without a more balanced approach, the government risks losing control over the very industry it seeks to regulate.
“The lack of clear regulations is already making institutions hesitant to fully engage with DeFi, as traditional banks and financial players require legal certainty before committing resources. However, institutional appetite for DeFi is growing, with major players like JPMorgan’s ONYX project exploring tokenized assets and blockchain-based settlements.”
Despite regulatory uncertainty, DeFi continues to attract investors with high-yield opportunities, with some protocols offering returns as high as 27–30%, and Navazan warns that excessive regulation could also lead to increased tax evasion.
“While the sustainability of such yields is debatable, the reality is that they continue to attract investors. If stringent reporting requirements push DeFi activity into underground or unregulated markets, tax authorities may lose visibility over transactions altogether, ultimately reducing the tax revenues they aim to collect.”
How DeFi regulations should Work
With the IRS rule repealed, DeFi platforms are no longer under immediate threat of being forced into a centralized reporting model. However, this does not eliminate the need for a workable regulatory and tax framework.
The challenge now is whether policymakers can develop regulations that align with DeFi’s decentralized architecture rather than attempting to retrofit outdated financial models onto a system designed to operate autonomously.
Navazan believes that instead of imposing reporting requirements that decentralized protocols cannot fulfill, regulators should focus on blockchain-native compliance solutions.
“A more effective DeFi tax policy would focus on leveraging blockchain technology itself rather than trying to force broker-style compliance on DeFi protocols. Rather than relying on DeFi platforms to collect and report user data, tax authorities should use blockchain-based compliance solutions that align with the decentralized nature of these platforms.”
One approach gaining traction is the use of on-chain analytics tools for tax enforcement. Companies like Chainalysis and Elliptic provide tracking software that allows regulators to monitor transactions and detect potential tax evasion—without forcing DeFi platforms into a compliance role.
Navazan highlights 1inch’s own efforts in implementing self-regulatory tools as an example of how the industry is already taking proactive steps to improve security and compliance.
“One potential solution is the use of on-chain analytics tools to trace transactions and identify illicit activity. For example, 1inch has already implemented self-regulatory measures through 1inch Shield API, which includes wallet screening and blacklisting to enhance security. However, these tools do not replace the need for clear, enforceable regulatory frameworks.”
Another possible model is permissioned DeFi, where institutional players interact with vetted liquidity pools that meet specific compliance standards.
Some DeFi projects are already developing institutional-friendly solutions that integrate risk monitoring and pre-approved pools with verified participants, ensuring compliance without entirely sacrificing decentralization.
Navazan sees this as a potential compromise for regulators seeking oversight while maintaining DeFi’s core principles.
“Rather than attempting to impose unworkable broker-reporting obligations, the IRS should explore blockchain-native tax reporting mechanisms that align with DeFi’s decentralized architecture. A tiered regulatory approach that differentiates between permissionless and permissioned DeFi could offer a more balanced solution.”
Such a model would allow regulators to focus on areas of DeFi that directly interact with traditional finance — such as stablecoin issuers and institutional liquidity pools — while allowing fully decentralized protocols to operate without burdensome compliance requirements.
Is U.S. crypto policy stuck in a political cycle?
Crypto policy in the U.S. has remained in flux, shifting with each administration and creating an unpredictable environment that makes long-term business planning nearly impossible. This lack of regulatory consistency has left the U.S. in a precarious position.
Without a stable framework, crypto businesses, institutional investors, and DeFi developers must navigate a system where the rules can change every few years.
Navazan sees the U.S.’s failure to establish a long-term crypto strategy as one of the biggest barriers to institutional adoption.
“U.S. crypto regulation is caught in a cycle of shifting policies. One administration pushes for aggressive regulation, the next rolls it back, and the cycle repeats. Without stable policy, institutional adoption of DeFi will always remain limited.”
The contrast with Europe is striking. The European Union’s Markets in Crypto-Assets regulation provides a unified legal framework for crypto, offering companies clear, standardized guidelines across the region.
In the U.S., by comparison, there is no single overarching crypto regulation. Instead, businesses must contend with a fragmented system where agencies like the SEC, CFTC, and IRS enforce competing interpretations of compliance.
Navazan argues that this disjointed approach threatens the U.S.’s leadership in digital assets.
“Companies operating in regulation-defined locations benefit from a streamlined regulatory framework that allows them to operate across Europe without requiring multiple licenses. This kind of stability makes it easier for businesses to plan long-term strategies — something that is currently lacking in the U.S.”
Against this backdrop, the upcoming White House Crypto Summit on Mar. 7 could be crucial. The event, expected to gather industry leaders such as Michael Saylor and Brian Armstrong, may influence the next phase of U.S. crypto regulation.
Whether the discussion leads to meaningful progress or becomes another political maneuver will determine whether the U.S. takes the lead in digital finance — or watches innovation move elsewhere.
