Senate Democrats have brought forward a new DeFi regulation

Senate Democrats are rolling out a proposal to crack down on illicit activity in decentralized finance, but it’s already drawing pushback from the crypto industry and Republicans.

The plan, introduced by several Democratic senators, includes measures that could see high-risk DeFi platforms placed on a “restricted list.”

Critics, including Blockchain Association CEO Summer Mersinger, have warned that the plan could drive the sector out of the U.S. entirely. Mersinger commented, “The language as written is impossible to comply with and would drive responsible development overseas,”  adding that the proposal would “effectively ban decentralized finance, wallet development, and other applications.”

Chervinsky says the proposal clashes with the CLARITY Act

According to Punchbowl News, Senate Democrats on the Banking Committee have already circulated a proposal to Republicans that would extend KYC obligations to crypto app frontends, such as non-custodial wallets, and roll back protections for developers.

The six-page draft reportedly gives the Treasury Department and other regulators authority to determine when a person or organization has control or significant influence, as well as whether a protocol qualifies as decentralized. It would also define as intermediaries anyone who designs, deploys, or operates a front-end service for a DeFi protocol, or who materially benefits from one involved in financial activities.

Crypto lawyer Jake Chervinsky has openly challenged the initiative, stating that it could both jeopardize the work on establishing a coherent framework and undermine the bipartisan efforts being made with the CLARITY Act.

He commented, “Senate Democrats are trying to kill market structure. A group just sent a counter-proposal to the RFIA, and it is deeply unserious. These Senators claim to be pro-crypto, but what they propose is basically a crypto ban.”

Moreover, he argued that the proposal looked like something SEC Chair Gary Gensler might have written, saying it was “so bad,” given that it came from supposed crypto allies. He added that the plan is deeply flawed, would label nearly everyone in crypto as an intermediary, and force front-end providers to conduct KYC checks — likely driving U.S. DeFi firms offshore.

Gabriel Shapiro, founder of MetaLeX Labs, also pointed out that DeFi protocols would still face mid-level regulation even if they were deemed suffıciently decentralized, unless they prohibited U.S. users from directly entering them and had no recurring profit-making situation.

Still, Chevinsky did acknowledge that the bill contains some good provisions, such as protection for software developers against unreasonable regulations and prosecution, which he said would help avoid a return to the era of Gary Gensler.

Mazhar asked lawmakers to craft measures that support innovation instead

Crypto players also voiced their concerns about the Democrats’ proposal. Zunera Mazhar, vice president of government and policy affairs at the Digital Chamber, criticized the measures as overly aggressive and counterproductive, warning they could drive innovation overseas without tackling the real issues.

She suggested that legislators should focus their attention on the real causes of illegal activities, adopt a risk-based strategy, and incentivize innovation, adding that “Good policy doesn’t punish decentralization.”

Mersinger also called the draft “disappointing,” saying it’s inconsistent with America’s long tradition of leading on innovation. She emphasized that any market structure framework must prioritize strong DeFi safeguards, calling on Congress to take the time to get it right. Additionally, she emphasized that the goal should be to establish clear standards that protect consumers without stifling innovation in the United States.

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