IRS’s DeFi Broker Rule Faces Backlash, Ripple CTO Highlights Risks

• IRS’s new DeFi rule could undermine decentralization by imposing KYC requirements.
• The IRS’s “broker” definition conflicts with SEC and CFTC regulations in crypto.
• Ripple CTO warns that users may turn to unsafe, anonymous DeFi platforms.

The IRS’s finalization of the second half of its controversial broker rule marks a significant shift in the regulatory landscape for decentralized finance (DeFi). Jake Chervinsky, the CLO of Variant Fund, stated that by the start of 2027, the rule would require a lot of DeFi front-ends to enforce Know Your Customer (KYC) processes for their users. 

This decision has sparked outrage in the crypto community, with critics arguing that the rule is an overreach of governmental power. Further, they stated that it violates constitutional rights, posing a threat to innovation in the DeFi space.

IRS has finalized the second half of its broker rule, requiring most DeFi front-ends to KYC users starting in 2027.

This unlawful rule is the dying gasp of the anti-crypto army on its way out of power.

It must be struck down, either by the courts or the incoming administration.

— Jake Chervinsky (@jchervinsky)
December 27, 2024

The Rule’s Far-Reaching Implications

The new rule, which is highly criticized as an unconstitutional expansion of IRS power, imposes KYC obligations on DeFi platforms, challenging the fundamental principles of decentralization. When the rules were initially proposed, thousands of pages of public comments were submitted. Experts argued the rule exceeded the IRS’s statutory authority and violated the freedom outlined in the Bill of Rights.

A Misunderstanding of ‘Broker’ Definitions

The core issue lies in the IRS’s interpretation of the term ‘broker.’ In the context of tax law, the word ‘broker’ is defined differently from its meaning under securities laws. The IRS’s definition of a broker applies specifically to tax reporting, while securities regulators like the SEC or CFTC deal with brokers in the context of market transactions. 

Read also : Ripple CTO Differentiates Crypto Staking from Traditional Income Amid IRS Tax Ruling

This discrepancy has led many to question why the IRS, rather than the SEC or CFTC, is leading the charge in defining broker rules in the crypto space. Further, critics warn that this misalignment could create unintended consequences for the broader regulatory framework of crypto markets.

Ripple CTO’s Warning: DeFi Users Will Seek Anonymity

Ripple’s CTO has weighed in on the issue, emphasizing the practical implications of the new rule. According to the CTO, the rule’s enforcement could lead to a surge in the use case of DeFi front-ends that are built anonymously. 

The practical effect of this rule will be that more Americans will use unsafe and anonymous DeFi front-ends based in bad actor jurisdictions.

— David “JoelKatz” Schwartz (@JoelKatz)
December 28, 2024

On the other hand, Kk_capital argued that it would take only a few minutes to redeploy a front-end on bare metal servers in jurisdictions with weak regulatory frameworks, which allow users to bypass KYC requirements completely. Consequently, this could drive more American users to less secure platforms and ultimately putting them at greater risk.

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