Author: Raks Sondhi, COO of Freedx
Governance of a composable, borderless, and programmable ecosystem using rules designed for a simple, static financial system poses a fundamental challenge. In just the past year, over $60 billion in crypto assets have been locked in DeFi platform protocols. However, most jurisdictions still lack a clear definition of decentralized autonomous organizations (DAOs). This ambiguity is slowing the pace of innovation and undermining the credibility of regulators.
Legislators still assume there exists a centralized entity that can issue licenses, audit, or subpoena. However, DAOs are intentionally decentralized, smart contracts operate autonomously, and on-chain assets can be transferred without permission. Although U.S. regulators have begun to pursue relevant protocols under existing securities laws, courts are still grappling with whether autonomous software can be held accountable. Traditional regulatory tools are not designed for real-time evolving systems. These challenges are prompting regulators around the world to explore new paths for crypto regulation.
Globally, the Markets in Crypto-Assets Regulation (MiCA) seeks to provide a unified framework for regulation in the EU, even restricting the use of tokens that do not meet its standards, such as USDt (USDT) issued by Tether. In the U.S., the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have filed lawsuits against DAO participants and DeFi protocols. Some states, like Wyoming, have even passed laws granting DAOs a form of corporate legal status.
As legislators chase an object that cannot be still
However, these efforts seem very limited and overly reliant on ex-post enforcement, creating a chilling effect: developers hesitate to push forward, funds stagnate, and regulation and innovation become trapped in a cat-and-mouse game that benefits no one, failing to truly address the issues. They are merely patching up an extremely dynamic and rapidly evolving space.
Governance of software through embedded compliance
So how do we stop this chase? The answer lies in some form of "policy as code" solution. We should no longer try to fit decentralized technology into traditional legal frameworks but instead build a new policy infrastructure that is as composable and programmable as the regulated technology itself. We must construct the compliance layer directly into the code, embedding regulatory logic into the infrastructure of DeFi protocols.
Just as on-chain financial tools are now composed of interoperable modules, a lending protocol should be able to connect to specific compliance modules based on the requirements of its jurisdiction. A DAO treasury should be able to automatically report in the event of a tax event. A stablecoin protocol should be able to execute sanctions lists through zero-knowledge proofs or on-chain verification mechanisms, and so on.
Some projects are already developing privacy-preserving and on-chain compliance components. Others are building permissioned control architectures that meet regulatory requirements. Even some centralized exchanges are exploring on-chain compliance paths that can be used for decentralized protocols.
Legal clarity is key to unlocking the full potential of DeFi
From a market perspective, embedded compliance has the potential to reduce risks in DeFi, attracting new investors and users. The legal clarity brought by embedding policy directly into the infrastructure will narrow the enforcement gap and enhance consumer protection. For developers, this unlocks the composability of the regulatory framework, allowing them to choose jurisdictional templates as easily as selecting UI components, adjusting their codebase in real-time according to policy changes. No longer will they need to guess whether their DAO tokens qualify as securities, nor will they have to struggle with whether protocols need to fulfill reporting obligations, and they will no longer rely on expensive legal interpretations.
While "policy as code" sounds appealing, programmable policy also carries its risks. Like any interconnected environment, there is a possibility of code being exploited. We must consider what happens when compliance modules are attacked, fail, or become outdated. Governance, security, and upgradability remain crucial, but democratic oversight is a pillar of blockchain technology. Embedding regulation into code should not mean stripping it from public accountability; otherwise, it will undermine trust and transparency, further hindering the mainstream adoption of Web3.
We are at a crossroads: either we reimagine the intersection of DeFi and law, or we allow the gap between regulation and permissionless innovation to widen. One path leads to an inclusive, efficient, and transparent financial system governed by rules that are visible and understandable to all.
The other path leads to gray markets, chaotic enforcement, and capital flight.
Policies must evolve and adapt in a modular way to new structures, new logics, and new ecosystems. The key to achieving this is governing software with software.
Author: Raks Sondhi, COO of Freedx.
Related: Pakistan's cryptocurrency minister discusses Bitcoin (BTC) with New York City mayor and Wall Street
Original: “Programmable Regulation is the Missing Key to the Legal Future of Decentralized Finance (DeFi)”
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