As Bitcoin continues to rise and institutional investors pour over $20 billion into crypto ETFs, a fundamental shift is occurring in the digital asset markets. The appointment of Paul Atkins as SEC chairman, known for preferring market-driven solutions to heavy-handed enforcement, has fueled optimism that cryptocurrencies can finally balance innovation with regulation.
But the crypto industry faces a stark choice that no amount of regulatory flexibility can overcome: sacrifice the unlimited programmability that makes these systems revolutionary, or accept that their compliance from an anti-money laundering regulatory perspective cannot be fully automated. nor join the system. . This is not a temporary technological limitation of one system or another: it is as fundamental as the laws of mathematics.
Market Integrity Automation
To begin to see 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 own 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 becomes a surveillance challenge.
Blockchain technology solves that problem. If everyone sees where all the projectiles are all the time, then law enforcement works. We can build compliance into a system and deny prohibited transactions. Here, the transparency of blockchain enables automated compliance.
But Web3’s long-standing premise is to automate stock exchanges and a host of complex interactions. Doing so requires moving beyond shells to a system where users create their own assets and load their own programs. And access without permission to publish these complex programs causes problems for users who may be exposed to malware or scams, for the system that may face congestion, and for regulators who care about preventing financial crimes.
The central challenge lies in what computer scientists call “undecidability.” In traditional finance, when regulators impose rules such as “do not transact 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 is mathematically impossible to check in advance whether a new piece of code might violate these rules.
JPMorgan’s recent name change from Onyx to Kinexys illustrates this reality. The platform now processes more than $2 billion in transactions daily, and participation is from 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 such as BlackRock and State Street, which together have more than $15 trillion in assets under management. Many cryptocurrency enthusiasts consider such restrictions to betray the promise of the technology. These commitments are not just pragmatic options: they are necessary for any system that aims to ensure 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 took a strong enforcement approach to cryptocurrency markets, treating most digital assets as securities requiring strict supervision. While Atkins’ anticipated principles-based approach might seem more adaptable, it cannot change the underlying mathematical constraints that make automated compliance impossible in fully programmable and permissionless systems.
The limitations of fully automated systems became painfully clear on MakerDAO, one of the largest decentralized lending platforms with over $10 billion in assets. During the market turmoil of 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 bring down 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 $2 billion loss. Similar incidents at Compound and Aave, which together manage another $15 billion in assets, underscore that this was not an isolated case. This was not just a technical failure: it demonstrates the impossibility of programming systems to handle all potential scenarios while maintaining regulatory compliance.
Towards compatible cryptography
The industry now faces three paths forward, each with different implications for investors:
First, follow JPMorgan’s lead and create 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 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 taken by Ripple with its recently launched RUSD, designed to meet New York Department of Financial Services standards based on the limited purpose trust company framework. While this limits innovation by restricting the space for action that users can take, it allows for decentralization within carefully defined boundaries.
Third, continue to pursue unlimited programmability while accepting that such systems cannot offer strong regulatory guarantees. This path, chosen by platforms like Uniswap with its total trading volume of more than $1 trillion in 2024, faces growing challenges. Recent regulatory actions against similar platforms in Singapore, the United Kingdom 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. The current market enthusiasm, largely driven by regulated products such as ETFs, indicates that the industry is moving towards the first option. Projects that recognize and address these fundamental limitations, rather than combating 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 of the next chapter of cryptocurrencies will likely be hybrid systems that balance innovation with practical limitations. Investment opportunities exist both in regulated platforms that provide clear compliance guarantees and in innovative projects that carefully limit their scope to achieve verifiable security properties.
As this market matures, understanding these mathematical limitations 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 limits of automated compliance. Just as physics limits what is possible in the physical world, these mathematical principles set immutable limits in financial technology. The pipe dream isn’t cryptocurrency itself: it’s the notion that we can have unlimited programmability, complete decentralization, and guaranteed regulatory compliance all at the same time.
For the crypto industry to harness its revolutionary potential, it must first recognize these immutable limitations. The winners in this next phase will not be those who promise to overcome these mathematical limits, but those who design intelligent ways to work within them.
