“A Misguided Rush to Regulate” - 1inch Labs CCO on IRS Approach to DeFi as Senate Overturns Rules
Can DeFi Survive Under Outdated Financial Regulations? Experts say forcing decentralized platforms into compliance models designed for banks would be disastrous, demonstrating why policymakers need to rethink their approach.
Table of Contents:
- Senate Vote to Overturn IRS Rule
- IRS Rule and Its Override
- Economic Consequences – Driving DeFi Underground?
- How DeFi Regulation Should Work
- Is US Crypto Policy Stuck in a Political Cycle?
Senate Vote to Overturn IRS Rule
The US government’s long-standing feud with decentralized finance (DeFi) has reached another critical juncture. On March 4, in a rare show of bipartisanship, the Senate voted overwhelmingly 70-27 to repeal an IRS rule that would impose traditional financial reporting requirements on decentralized exchanges and DeFi protocols.
If the rule goes into effect, it would force DeFi developers and platforms to report cryptocurrency transactions to the IRS, effectively treating them like regular financial intermediaries. The resolution now heads to the House for a vote before landing on President Donald Trump’s desk. With the backing of President Trump and David Sacks, Trump’s AI and crypto czar, the measure is likely to quickly become law.
Cryptocurrency advocates see this as a major win for privacy and financial innovation. But with the House vote still pending and regulatory uncertainty lingering, the battle over DeFi’s legal status is far from over.
IRS Rule and Repeal
The now-repealed IRS rule sought to impose traditional financial reporting obligations on DeFi protocols, effectively classifying them as brokers.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 don’t hold user funds or act as financial intermediaries.
Introduced under the Biden administration as part of a tax compliance effort in the crypto space, the rule was intended to address the estimated annual tax gap caused by unreported crypto transactions. However, the proposal has been met with fierce opposition from industry experts like Hedi Navazan, Chief Compliance Officer at 1inch Labs.
Navazan argues that the IRS misunderstands how DeFi works. “This proposal reflects a rush to regulate without a clear understanding of the technical complexities involved. Many DeFi protocols, including decentralized exchange aggregators, do not hold user assets, making traditional regulation unfeasible.”
Economic consequences – driving DeFi underground?
A growing concern is that overregulation could push DeFi activity out of the United States, as has happened to centralized exchanges. Navazan warns that rigid or vague policies do not promote compliance, but simply force innovation out of the United States.
For example, 2023 saw the relocation of many large companies, including Coinbase and Gemini, due to the lack of a clear regulatory framework. DeFi protocols are also beginning to move their development teams and legal entities to more friendly jurisdictions.
In addition, crypto privacy tools can thrive in a climate of overregulation. The US Treasury Department’s sanctions on Tornado Cash did not eliminate the need for anonymous transactions, but only pushed users to alternative platforms.
How DeFi Regulation Should Work
Despite the IRS rule’s repeal, DeFi platforms still need a viable legal and tax framework. Navazan suggests that policymakers should focus on blockchain-native compliance solutions, rather than trying to force decentralized platforms to adhere to antiquated compliance models.
One solution is to use on-chain analytics to detect tax evasion without forcing DeFi platforms to act as intermediaries. Additionally, DeFi projects have implemented self-regulatory measures such as the 1inch Shield API, which enhances security by filtering wallets and blacklists.
Navazan suggests that the IRS explore blockchain-based tax reporting mechanisms and differentiate between permissioned DeFi and permissionless DeFi to strike a balance between oversight and upholding decentralized principles.
Is US Crypto Policy Stuck in a Political Cycle?
US crypto policy is in a volatile loop, with each new administration changing its approach.
