Senate Democrats' Leaked Crypto Position Would Strangle DeFi, Industry Insiders Say

The crypto industry is recoiling from a document reportedly outlining a U.S. Senate Democratic pitch on handling decentralized finance (DeFi) as a component of the wider effort toward regulating crypto in the U.S.

The proposal — a detailed outline describing an approach to DeFi, first reported by Politico — suggests that a firm or individuals that handle customer needs on the front end of a DeFi operation should have to register with the Securities and Exchange Commission or the Commodity Futures Trading Commission and be regulated as a broker.

The language defining who would be roped into regulation as an intermediary would seem to include "everyone in crypto," according to a take posted on social media site X from Jake Chervinsky, the chief legal officer at Variant.

"Many aspects of the proposal are fundamentally broken and unworkable," he argued. "This is not a 'first offer' in a negotiation; it’s a list of demands that appear designed to kill the bill."

Summer Mersinger, who runs the Blockchain Association and was recently a commissioner at the CFTC, said the proposal "would effectively ban decentralized finance, wallet development and other applications in the United States."

"The language as written is impossible to comply with and would drive responsible development overseas," Mersinger said in a statement. "We urge our policymakers to stay at the table."

Before the Senate's crypto market structure work fell into the shadow of the ongoing negotiation to reopen the federal government, Senate Republicans and Democrats were circling each other over legislative language and seemed to be in range of making progress on a final, combined bill. But the industry was bracing itself in August for expected pushback from Democratic Senator Mark Warner, a key lawmaker on national security issues who has raised concerns about illicit finance in crypto.

This latest proposal seemingly seeks to allow the Treasury Department, markets regulators and the Federal Reserve to squeeze bad actors by letting the government agencies identify those they can hold accountable for DeFi activity, described loosely as "anyone designing, deploying, operating or profiting from a DeFi front-end." However, it holds that pure DeFi protocols that aren't making money can be defined as "sufficiently decentralized" to be outside of the regulatory perimeter.

The proposal also seeks to free software developers from legal liability for their open-source creations, as long as they don't make money from running the technology. This liability question has been among the core concerns of the DeFi space.

Meanwhile, lawmakers in the House of Representatives, where a market structure already passed with a wide margin, have been calling for the Senate to just go ahead and use their Digital Asset Market Clarity Act as a template instead of starting over.

However, Senate legislation is more dependent on bipartisan support in order to clear the usual 60-vote requirement. While the crypto work has a long list of Democratic allies, they've made it clear that there are a number of changes they're seeking in the previous Republican legislative drafts before they can jump on board.

Read More: A16z, DeFi Group Pitch U.S. SEC on Safe Harbor for DeFi Apps