The latest development from Capitol Hill sees the U.S. Senate gearing up to attempt another swipe at the crypto industry. The new bill, aptly named the Crypto-Asset National Security Enhancement Act of 2023, could impose hardline anti-money laundering (AML) requirements on decentralized finance (DeFi) protocols. The bill, however, fails to consider the unique dynamics of DeFi, which could render its provisions unenforceable and counterproductive.



Per the draft text, the Act would require DeFi protocols to take on regulatory responsibilities similar to those that banks currently shoulder, seemingly overlooking the decentralized nature of these protocols. The Act’s rationale is to curtail the rise in crypto-related crime and enhance control over potential money laundering and sanctions avoidance activities.



Decentralized finance (DeFi) protocols, innovative financial applications allowing anyone with a crypto wallet to borrow, lend, and trade cryptocurrency via smart contracts, operate on permissionless blockchains, making them much less prone to centralized control. By virtue of their structure, they prove more resistant to regulation than centralized entities like Coinbase.



The bill appears to be misconstrued in its approach to tackling the decentralized nature of DeFi. It proposes to bypass the inherent challenges of control in DeFi by imposing responsibilities on “anyone who ‘controls’ a DeFi protocol or makes available an application to use the protocol.” This might indirectly target groups who create user-friendly interfaces for the often complex smart contracts of protocols, such as Uniswap Labs for Ethereum’s leading decentralized exchange.



Furthermore, the bill’s “backstop” provision suggests that anyone investing over $25 million in developing a protocol would be liable for these regulatory duties. This could potentially deter much-needed investment and innovation in the sector.



The Act aims to enforce vetting, customer information collection, anti-money laundering measures, reporting of suspicious activities to authorities, and the barring of sanctioned individuals from using the protocols on these controlling entities. These proposed regulations, however, seem to defy the underlying principles of decentralization and privacy upon which crypto thrives. DeFi’s essence lies in its open, permissionless, and trustless nature. Attempting to impose bank-like regulations on an industry designed to challenge and improve upon traditional banking’s shortcomings doesn’t quite add up.



Moreover, the bill seeks to expand the Treasury Department’s purview to pursue alleged money launderers in unconventional financial settings, including crypto. This could be seen as an overreach into the financial sovereignty and privacy of crypto users.



In essence, this legislation seems to misunderstand the fundamentals of DeFi and crypto at large. The potential consequence? Stifling the nascent industry’s innovation and driving it offshore. Rather than attempting to fit a square peg in a round hole, lawmakers should look to develop more nuanced and understanding regulations, appreciating crypto’s unique benefits and potential.