The Internal Revenue Service (IRS) has communicated new rules for the decentralized finance (DeFi) industry, sparking up debates in the crypto industry. According to the new rules, DeFi platforms will be classified as brokers, which will in turn mean that they must mandate KYC and report specific transactions. Every aspect of the rule poses significant risks and could impact the future of the DeFi industry.
Platforms such as Uniswap, which oversees buying and selling through smart contracts would be included in the scope, posing a serious challenge to the industry. The regulation would stifle innovation and push companies abroad to find better regulations. With the deadline swiftly approaching, Galaxy Digital Head of Research Alex Thorn has mentioned possible paths to navigate the rules if they are not reversed.
Total compliance or blocking US-based users
The first option will be for platforms to comply with the directive, ordering users to do KYC and begin transaction reporting. However, it will be hard for some platforms because they are controlled by decentralized autonomous organizations (DAOs). Coupled with leaving their upgradeable smart contracts, it will be hard for them to initiate the changes. This means that users who value privacy and decentralization will be cut off.
Another alternative will be to block United States users from accessing DeFi platforms. Most platforms will prefer to shut down their services, while others will restrict US-based users to some transactions. Although the measure will help platforms mitigate regulations, it has also limited exposure to potential users. This would mean a fragmented DeFi ecosystem, with users pushed to where regulations will be easier to follow. With United States users excluded, it may hamper the growth of the global DeFi industry.
Thorne proposes a deep decentralization
According to Thorne, protocols could explore another option, choosing a full decentralization. But this means they will have to forgo revenue generation and smart contract upgrades. It also means they will remove any hint of centralization, which will include front ends. All activities will need to be carried out using immutable smart contracts and community governance.
The approach aligns with the tenets of decentralization, which will see protocols lose the broker tag. It also means they will not be mandated to follow all the other requirements. However, the protocols need to give up their user-friendly interfaces, profits, and upgrades. The new rules are expected to cover 875 protocols, affecting more than 2.6 million United States taxpayers.
However, critics have voiced out about the harm the new rule may have on the United States crypto industry. They fear that innovation may suffer, noting that things could shift away from the country. The Blockchain Association has also complained about the rules, expressing strong opposition to it. With the new IRS regulations, it strongly remains the option of the DeFi platforms what they choose to do.