Democrats Propose ‘Restricted List’ for DeFi Protocols in Bill That Could ‘Kill’ Sector

Senate Democrats sent Republicans a counter-proposal on Thursday that would permit the Treasury Department to create a “restricted list” for DeFi protocols deemed too risky, triggering an immediate halt to bipartisan crypto market structure negotiations.

The proposal would impose Know Your Customer rules on crypto app frontends, including non-custodial wallets, strip protections from crypto developers, and potentially punish US nationals who use restricted protocols and generate recurring revenues from them.

GOP Suspends Talks as Bipartisan Show Their Cards

GOP staff suspended all crypto talks after receiving the Democratic offer, with Senate Banking Committee Republican Staff Director Catherine Fuchs writing in an email that meetings would pause “until we have an agreed upon date for markup.”

Republicans criticized the proposal as not written in legislative text, containing incoherent policy ideas, and representing a bad-faith negotiation effort rather than a serious regulatory framework.

Crypto lawyer Jake Chervinsky stated that the counter-proposal might eliminate any opportunity to establish a structured crypto market framework.

He warned that it could weaken the bipartisan backing the CLARITY Act gained in the House in July, where it passed with a vote of 294-134.

Chervinsky described the proposal as an “unprecedented, unconstitutional government takeover of an entire industry” that doesn’t regulate crypto but effectively bans it.

The Democrats behind the counter-proposal include Mark Warner, Ruben Gallego, Andy Kim, Reverend Raphael Warnock, Angela Alsobrooks, and Lisa Blunt Rochester.

The clash threatens the GOP-led effort to pass landmark crypto legislation this year.

Senate Banking Chair Tim Scott and other Republicans have rushed to pass a market structure bill before year-end, but struggled to attract the necessary bipartisan support.

The dispute comes as the AFL-CIO urged the Senate Banking Committee on October 7 to oppose the Responsible Financial Innovation Act, warning the legislation would expose workers’ retirement funds to crypto volatility while increasing systemic financial risk.

Industry Leaders Warn Proposal Would Push Innovation Offshore

Blockchain Association CEO Summer Mersinger warned the Democratic proposal would “make compliance impossible, pushing responsible development and the next wave of financial technology offshore.”

She said DeFi might survive but would thrive overseas rather than in the United States, urging “policymakers to stay at the table and continue engaging across the aisle” to ensure legislation supports rather than hinders American leadership in financial technology.

Similar to Mersinger, Digital Chamber Vice President Zunera Mazhar also criticized the draft for trying to “fight illicit finance with outdated tools”, giving Treasury sweeping authority while narrowly defining decentralization and treating frontends like financial intermediaries.

She also called for targeting “real chokepoints where illicit finance occurs” through risk-based oversight instead of regulating code or governance, aligning with global standards rather than creating uncertainty.

Among many other industry leaders who have voiced their concerns on the proposal, the CEO of Coinbase, Brian Armstrong, joined them, saying, “It’s a bad proposal, plain and simple, that would set innovation back, and prevent the US from becoming the crypto capital of the world.”

The counter-proposal clashes with the Senate Banking Committee’s Responsible Financial Innovation Act draft from September 7, a bipartisan effort assigning the Commodity Futures Trading Commission oversight of spot markets while reducing Securities and Exchange Commission overreach.

The RFIA draft introduced protections for DeFi developers, ensuring they can build without fear of prosecution following recent cases involving Tornado Cash and Samourai Wallet developers.

Bipartisan Negotiations Collapse Over Process and Substance

According to Politico, Senate Democrats involved in negotiations defended their approach, with Senator Ruben Gallego spokesperson Jacques Petit saying Democrats showed up ready to work but Republicans “are crashing out.”

Petit stated Democrats delivered paper and substance as requested, only for Republicans to leak the proposal and pretend surprise at policy differences.

He called Republican demands to set a markup date before text agreement “like setting a wedding date before the first date.”

Republicans counter that they repeatedly asked for legislative feedback since June 27 without receiving formal, substantive input on discussion drafts.

Senate Banking Chair Tim Scott’s spokesperson, Jeff Naft, said Chairman Scott pushed the September 30 markup date, hoping for bipartisan engagement, and asked multiple times for Democrats to commit to a markup date necessary to move legislation forward.

Gallego leads a group of twelve crypto-friendly Senate Democrats negotiating the bill, including Kirsten Gillibrand, Mark Warner, Angela Alsobrooks, and Cory Booker.

They face opposition from other party members like Senate Banking ranking member Elizabeth Warren, who has always been an anti-crypto advocate who believes that crypto poses risks to financial stability and national security.

Gallego told reporters late Thursday that Democrats would continue working but refuse to be pushed into setting artificial deadlines for a vote while remaining committed to achieving a bipartisan market structure bill.

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