The decentralized finance (DeFi) sector is experiencing a moment of relief as lawmakers ease reporting requirements, yet uncertainty linger about the future of DeFi regulation.
On March 12, the House of Representatives voted to rescind a regulation that mandated DeFi protocols to disclose gross earnings from cryptocurrency transactions and provide details on involved taxpayers to the Internal Revenue Service (IRS).
This regulation, introduced by the IRS in December 2024 and scheduled to come into effect in 2027, was viewed by prominent industry advocates as excessively burdensome and outside the agency’s jurisdiction.
The administration has already expressed its backing for the legislation, with the President ready to endorse it once it lands on his desk. However, experts in the DeFi arena point out that a compromise between privacy needs and regulatory practices has yet to be achieved.
Bipartisan support for repealing the regulation.
Concerns About Privacy with IRS DeFi Regulations
She remarked that it is “crucial to safeguard people’s ability to engage directly with one another through open-source code (such as smart contracts and decentralized exchanges) while maintaining anonymity, similar to cash transactions.”
Privacy issues were central to the industry’s opposition to the rule, with many asserting that it was inappropriate and violated user rights. Bill Hughes, senior counsel and director of global regulatory matters at Consensys Software, emphasized in December 2024 that “trading front ends would have to monitor and report on user activity — both for U.S. persons and international users […] This applies to all types of digital assets, including NFTs and stablecoins.”
A significant industry lobbying group stated that the rule represented “an infringement on the privacy rights of individuals utilizing decentralized technology,” potentially forcing DeFi activities offshore.
Although the rule has been halted for now, definitive privacy guidelines have yet to be established—an aspect Etherealize CEO Vivek Raman believes is essential for the industry’s progress.
“We require clear frameworks for blockchain-based privacy while effectively complying with Know Your Customer and Anti-Money Laundering demands,” he mentioned.
Raman argued that certain transactions and user data must remain confidential, asserting, “We need direction on how privacy can be integrated.”
Regulatory Challenges in DeFi
The cryptocurrency sector has long grappled with the balancing act between user privacy wishes and regulatory concerns regarding Anti-Money Laundering and Know Your Customer protocols.
A significant challenge arises from the nature of DeFi technology—if a network is collaboratively created and not controlled by any single entity, who is accountable to the government?
Raman remarked, “It’s challenging for a decentralized protocol, which nobody controls, to issue 1099s or meet broker-dealer responsibilities! While companies can be [broker-dealers], the software isn’t designed to comply with [broker-dealer] regulations.”
DeFi developers have been proactive in engaging with regulators, as Chainalysis noted, particularly when certain protocols took steps to freeze funds following the massive $285 million KuCoin hack.
However, these instances do not constitute a comprehensive regulatory framework that both the industry and protection agencies can reference.
In this context, it was highlighted by a crypto analytics firm in 2020 that regulators may need to develop regulations for the DeFi landscape, taking decentralized reporting limitations into account.
Raman proposed that one potential solution might involve zero-knowledge proofs, allowing users to validate specific data without disclosing it.
He remains hopeful about regulators’ ability to find a path toward regulation that retains user privacy: “I believe we will see an environment where DeFi and compliance can coexist positively.”
The Anticipated Crypto Regulatory Framework
The President has already undertaken various pro-crypto initiatives through executive orders and by appointing individuals supportive of cryptocurrency to key positions in his administration, including the recent establishment of a strategic Bitcoin reserve.
The tenure of influential financial regulators like the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) has led to multiple significant enforcement actions against crypto entities.
Nonetheless, the crypto industry is eagerly awaiting the comprehensive regulatory framework and stablecoin legislation being discussed in Congress, which could provide the necessary guidance it claims to need for proper growth.
On March 13, the Senate Banking Committee approved the GENIUS Act, a stablecoin bill, bringing it closer to being voted on in the Senate. Meanwhile, the crypto framework bill, FIT 21, was initially introduced in the 2024 legislative session but failed in the Senate. However, in February, the Chair of the House Financial Services Committee expressed optimism that the bill could pass this session with “modest changes.”
Even with a swift approval of FIT 21, comprehensive DeFi regulations may still be a distant reality. The bill would likely exclude DeFi from the oversight of the SEC and CFTC but would also create a working group mandated to explore twelve important areas related to DeFi.
This research will aim to assess the risks and advantages of DeFi and will ultimately propose regulatory guidance.