Blockchain Groups Sue IRS Over DeFi Privacy Concerns

• Crypto groups sue the IRS over the DeFi broker regulation expansion.
• Legal battles endangered innovation and drove technology abroad.

On December 27, 2024, the IRS announced a revolutionary rule that may change DeFi. This rule classified decentralized finance (DeFi) platforms as brokers, meaning it requires them to follow Know Your Customer and report details of all transactions made through those platforms to the IRS. The regulations have become controversial in the industry as it compromises decentralization and user anonymity to take effect in 2027.

Originating based on the decentralized and privacy-oriented features of DeFi services which did not require oversight of the users’ central authority to perform financial activities, new regulations have imposed tough decisions on these platforms such as either complying or banning users from the U.S. or fully decentralizing.

The Future Battle Between the Law and DeFi

Complying with the IRS regulations requires DeFi platforms to collect personal information from its users and report transactions. For a number of platforms, particularly decentralized autonomous organizations or non-upgradable smart contract-based ones, making these changes impossible technically or financially unfeasible. Small platforms will have a tough time supporting the high costs of compliance, which may drive away users who value privacy and anonymity.

Others may simply ban users from the U.S. to avoid scrutiny under regulations altogether. This might give them the seeming comfort of relief from complying with the different burdens for a while. However, it could limit opportunities for growth as well as isolate a majority of potential users in the U.S.

Lastly, platforms may surrender totally to decentralization by giving in to the up-gradation of smart contracts and revenue-generating systems. In this scenario, they would not collect data from users or regulate any transactions and therefore would be out of the scope of the brokerage classification. However, this might go a long way to damaging the usability, innovation capabilities, and monetization capabilities of platforms.

Industry experts say the new rules could strangle innovation and drive DeFi development offshore, with a joint lawsuit already filed saying the regulations are unconstitutional.

With the compliance deadline looming, DeFi platforms are at a crossroads. The impact of this regulatory shift may change the future of DeFi radically, forcing the platforms to make some hard decisions on what they want to do or not do with their businesses and core values.