As Bitcoin continues to grow 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 chairman, known for favoring market-driven solutions over strict enforcement, has fueled optimism that crypto can finally balance innovation and 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 regulatory perspective money cannot be fully automated or integrated into the system. . This is not a temporary technological limitation regarding one system or another: it is as fundamental as the laws of mathematics.
Automating Market Integrity
To begin to understand why, we can think of an economy in which shells are money. If we pass a law that no one can transact more than 10 times a day or hold more than 10% of the shells, we will have an enforcement problem. How do we know who has which shells and when? Information asymmetry hinders compliance and compliance is a monitoring challenge.
Blockchain technology solves this problem. If everyone sees where all the shells are at all times, then law enforcement works. We can build compliance into a system and refuse prohibited transactions. Here, blockchain transparency enables automated compliance.
But the long-standing principle of Web3 is to automate exchanges and a myriad of complex interactions. Doing this requires moving beyond shells to a system where users create their own resources and upload their own programs. And unauthorized access to publish these complex programs poses problems for users who may be exposed to malware or scams, for the system which may face congestion, and for regulators concerned with preventing financial crimes.
The main challenge lies in what computer scientists call “undecidability.” In traditional finance, when regulators impose rules such as “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 check in advance whether a new piece of code might break these rules.
JPMorgan’s recent rebranding of Onyx to Kinexys illustrates this reality. The platform now processes more than $2 billion in transactions daily, and participation is done by participants who meet regulatory criteria before joining. Unlike traditional cryptocurrency platforms where anyone can write and deploy automated trading programs (known as smart contracts), JPMorgan’s system maintains compliance by limiting 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 these restrictions as a betrayal of the technology’s promise. These trade-offs are not simply pragmatic choices: they are necessary for any system aimed at ensuring regulatory compliance.
The Securities and Exchange Commission’s mandate to protect investors while facilitating capital formation has become increasingly complex in the digital age. Under the leadership of Gary Gensler, the SEC has taken a rigorous approach to crypto markets, treating most digital assets as securities requiring strict oversight. Although the principled approach anticipated by Atkins may seem more accommodating, it cannot change the underlying mathematical constraints that make automated compliance in fully programmable, permissionless systems impossible.
The limitations of fully automated systems have become painfully obvious at MakerDAO, one of the largest decentralized lending platforms with over $10 billion in assets. During the market turmoil in March 2024, when the price of Bitcoin swung 15% in a matter of hours, MakerDAO’s automated systems began triggering a cascade of forced liquidations that threatened to collapse the entire platform.
Despite years of refinement and more than $50 million spent developing the system, the protocol required emergency human intervention to prevent a loss of $2 billion. Similar incidents at Compound and Aave, which together manage another $15 billion in assets, highlight that this was not an isolated case. This was not simply a technical failure: it demonstrates the impossibility for programming systems to handle all potential scenarios while maintaining regulatory compliance.
Towards compliant crypto
The sector now faces three pathways, each with distinct implications for investors:
First, follow JPMorgan’s lead by creating permissions-based systems that sacrifice some decentralization in favor of clear regulatory compliance. This approach has already gained traction: six of the world’s ten largest banks have launched similar initiatives in 2024, collectively processing more than $2 trillion in transactions. The rise of regulated crypto products, from ETFs to tokenized securities, further validates this path.
Second, limit blockchain systems to simple, predictable operations whose compliance can be automatically verified. This is the approach Ripple is taking with its recently launched RUSD, designed to comply with New York Department of Financial Services standards based on the limited purpose trust company framework. While this limits innovation due to the restricted action space users can exercise, it allows for decentralization within carefully defined boundaries.
Third, continue to pursue unlimited programmability while accepting that such systems cannot provide strong regulatory guarantees. This path, chosen by platforms like Uniswap with a total transaction volume of more than $1 trillion in 2024, faces growing challenges. Recent regulatory actions taken against similar platforms in Singapore, the UK and Japan suggest that the days of this approach may be numbered in developed markets.
For investors navigating this evolving landscape, the implications are clear. Current market enthusiasm, largely driven by regulated products like ETFs, indicates that the industry is moving towards the first option. Projects that recognize 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 experiencing spectacular growth: JPMorgan’s platform reported a 127% increase in transaction volume this year.
The success stories in cryptography’s next chapter will likely be hybrid systems that balance innovation with practical constraints. Investment opportunities exist in both regulated platforms that offer clear compliance guarantees and in innovative projects that judiciously limit their scope to achieve verifiable security properties.
As this market matures, understanding these mathematical constraints becomes crucial to investors’ risk assessment and portfolio allocation. The evidence is already clear in market performance: regulated crypto platforms have generated 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 limitations of automated compliance. Just as physics limits what is possible in the physical world, these mathematical principles set immutable limits on financial technology. The impossible dream isn’t cryptocurrency itself – it’s the idea that we can have both unlimited programmability, complete decentralization, and guaranteed regulatory compliance.
For the crypto industry to realize its revolutionary potential, it must first recognize these immutable constraints. The winners in this next phase will not be those who promise to overcome these mathematical limitations, but those who devise intelligent methods to work on them.
