As Bitcoin continues to rise and institutional investors pour over $20 billion into crypto ETFs, a fundamental shift is occurring in digital asset markets. The appointment of Paul Atkins as SEC Chair, known for favoring market-driven solutions over heavy-handed enforcement, has fueled optimism that crypto can finally balance innovation with regulation.
But the crypto industry faces a stark choice that no amount of regulatory flexibility can overcome: either sacrifice the unlimited programmability that makes these systems revolutionary, or accept that their compliance from an anti-money laundering regulation perspective cannot be fully automated or built into the system. This isn’t a temporary technological limitation about one system or another – it’s as fundamental as the laws of mathematics.
Automating Market Integrity
To begin to see why, we can think about an economy where shells are money. If we pass a law that nobody can transact more than 10 times per day or hold more than 10% of the shells, we have an enforcement problem. How do we know who holds which shells when? Information asymmetry stymies compliance and compliance devolves to a surveillance challenge.
Blockchain technology solves that problem. If everyone sees where all the shells are all the time, then enforcement works. We can build compliance into a system and deny banned transactions. Here, the transparency from the blockchain enables automated compliance.
But the long-held premise of Web3 is to automate stock exchanges and myriad complex interactions. Doing so requires moving beyond shells to a system where users create their own assets and upload their own programs. And permissionless access to publish these complex programs causes trouble for users who may be exposed to malicious programs or scams, the system which may face congestion, and regulators who care about preventing financial crimes.
The core challenge lies in what computer scientists call “undecidability.” In traditional finance, when regulators impose rules like “no transactions with sanctioned entities” or “maintain capital adequacy ratios,” banks can implement these requirements through their existing control systems. But, in a truly decentralized system where anyone can deploy sophisticated smart contracts, it becomes mathematically impossible to verify in advance whether a new piece of code might violate these rules.
JPMorgan’s recent rebranding of Onyx to Kinexys illustrates this reality. The platform now processes over $2 billion in daily transactions, and participation is by participants who meet regulatory criteria before joining. Unlike typical cryptocurrency platforms where anyone can write and deploy automated trading programs (known as smart contracts), JPMorgan’s system maintains compliance by restricting what participants can do.
This approach has attracted major institutional players like BlackRock and State Street, which collectively have more than $15 trillion in assets under management. Many crypto enthusiasts view such restrictions as betraying the technology’s promise. These compromises are not just pragmatic choices – they’re necessary for any system that aims to guarantee regulatory compliance.
The Securities and Exchange Commission’s mandate to protect investors while facilitating capital formation has grown increasingly complex in the digital age. Under Gary Gensler’s leadership, the SEC took an enforcement-heavy approach to crypto markets, treating most digital assets as securities requiring strict oversight. While Atkins’ anticipated principles-based approach might seem more accommodating, it cannot change the underlying mathematical constraints that make automated compliance impossible in permission-less, fully programmable systems.
The limitations of fully automated systems became painfully clear at MakerDAO, one of the largest decentralized lending platforms with over $10 billion in assets. During March 2024’s market turbulence, when Bitcoin’s price swung 15% in hours, MakerDAO’s automated systems began triggering a cascade of forced liquidations that threatened to collapse the entire platform.
Despite years of refinement and over $50 million spent on system development, the protocol required emergency human intervention to prevent a $2 billion loss. Similar incidents at Compound and Aave, which together handle another $15 billion in assets, underscore that this wasn’t an isolated case. This wasn’t just a technical failure – it demonstrates the impossibility of programming systems to handle every potential scenario while maintaining regulatory compliance.
Towards Compliant Crypto
The industry now faces three paths forward, each with distinct implications for investors:
First, follow JPMorgan’s lead by building permission-based systems that sacrifice some decentralization for clear regulatory compliance. This approach has already gained significant traction: six of the top ten global banks have launched similar initiatives in 2024, collectively handling over $2 trillion in transactions. The surge in regulated crypto products, from ETFs to tokenized securities, further validates this path.
Second, limit blockchain systems to simple, predictable operations that can be automatically verified for compliance. This is the approach adopted by Ripple with its newly launched RUSD, designed to be compliant with the New York Department of Financial Services standards based on the limited purpose trust company framework. While this constrains innovation due to the restriction action space that users can make, it enables decentralization within carefully defined boundaries.
Third, continue pursuing unlimited programmability while accepting that such systems cannot provide strong regulatory guarantees. This path, chosen by platforms like Uniswap with its over $1 trillion in total trading volume in 2024, faces mounting challenges. Recent regulatory actions against similar platforms in Singapore, the U.K. and Japan suggest this approach’s days may be numbered in developed markets.
For investors navigating this evolving landscape, the implications are clear. The current market enthusiasm, largely driven by regulated products like ETFs, indicates the industry is moving toward the first option. Projects that acknowledge and address these fundamental constraints, rather than fighting them, are likely to thrive. This explains why traditional financial institutions’ blockchain initiatives, despite their limitations, are seeing dramatic growth – JPMorgan’s platform reported a 127% increase in transaction volume this year.
The success stories in crypto’s next chapter will likely be hybrid systems that balance innovation with practical constraints. Investment opportunities exist in both regulated platforms that provide clear compliance guarantees and innovative projects that thoughtfully limit their scope to achieve verifiable safety properties.
As this market matures, understanding these mathematical constraints becomes crucial for investors’ risk assessment and portfolio allocation. The evidence is already clear in market performance: regulated crypto platforms have delivered average returns of 156% over the past year, while unrestricted platforms face increasing volatility and regulatory risks.
Atkins’ principles-based approach might offer more flexibility than Gensler’s prescriptive rules, but it cannot override the fundamental limits of automated compliance. Just as physics constrains what’s possible in the physical world, these mathematical principles set immutable boundaries in financial technology. The impossible dream isn’t cryptocurrency itself – it’s the notion that we can have unrestricted programmability, complete decentralization and guaranteed regulatory compliance all at once.
For the crypto industry to deliver on its revolutionary potential, it must first acknowledge these immutable constraints. The winners in this next phase won’t be those promising to overcome these mathematical limits, but those who design intelligent ways to work within them.