DeFi regulation 2026: how traditional banks are entering on-chain finance legally

DeFi is no longer a niche segment of the crypto market and is increasingly intersecting with the traditional financial system. Banks are no longer limited to observation or pilot projects; they are starting to use on-chain tools for asset tokenization, settlements, and liquidity management. However, entering DeFi involves significant legal risks, from the lack of clear regulation to AML requirements and liability for smart contracts. In this context, the key challenge is not just access to the technology but its lawful integration. In this article, we examine how banks are entering DeFi, the risks they face, and the legal models that allow them to operate within regulatory frameworks.

Why DeFi is no longer outside the regulatory perimeter

DeFi no longer operates outside the legal framework. While a few years ago protocols were seen as experimental environments without clear jurisdiction, they are now becoming part of the global financial system and attracting regulatory attention.

The main driver is market growth and institutional involvement. According to the Bank for International Settlements, the integration of crypto assets with traditional finance increases market interconnection and systemic risk, prompting more active regulatory intervention.

Additional pressure comes from two factors:

• Growing volumes of funds flowing through DeFi protocols
• Use of these tools in services similar to traditional finance, such as lending, trading, and derivatives

As a result, regulators are applying the same principles used for traditional financial institutions, particularly in investor protection, AML, and risk management.

Importantly, regulation is applied not directly to protocols but through points of user interaction:

• Front-end interfaces
• Liquidity providers
• Custodial services
• Developers and infrastructure operators

This approach allows DeFi to be integrated into the existing legal framework without changing its technological nature.

The convergence of TradFi and DeFi

The line between traditional finance and DeFi is rapidly blurring. Banks no longer treat on-chain tools as experimental; they use them for concrete tasks such as settlements, asset issuance, and liquidity management.

From experimentation to institutional adoption

Where banks once relied on pilots and sandboxes, they are now integrating on-chain solutions into real operations. The main driver is efficiency, including lower settlement costs, faster execution, and access to global liquidity.

Major financial institutions are already testing on-chain infrastructure for:

• Interbank settlements
• Issuance of digital assets
• Automation via smart contracts

This shifts DeFi from an experimental space to part of financial infrastructure.

Tokenization and on-chain assets

The fastest growth is in tokenized assets (RWA). Banks issue bonds, funds, and other instruments on blockchain while maintaining control through legal structures.

According to industry data, the volume of tokenized real-world assets has already reached tens of billions of dollars and continues to grow on the back of institutional demand. The logic is straightforward: on-chain assets reduce costs and speed up settlement without losing regulatory control.

Stablecoins as a bridge

Stablecoins have become the main entry point for banks into DeFi. Unlike traditional crypto assets, they integrate more easily into existing financial systems.

Banks use them for:

• Cross-border payments
• Instant settlements
• Liquidity management

Annual stablecoin transaction volume already exceeds trillions of dollars, making them a core part of financial infrastructure.

Key legal challenges of DeFi for traditional banks

For banks, the main barrier is not technology but legal uncertainty. DeFi was built as an environment without centralized control, while banks must operate within clearly defined regulatory frameworks. This creates a fundamental mismatch between DeFi architecture and existing law.

Absence of a clear counterparty

In traditional finance, there is always a counterparty that can be contracted with and held accountable. In DeFi, interaction occurs with a smart contract or protocol that may lack a legal entity or fall outside any jurisdiction.

For banks, this means:

• Inability to identify a responsible party
• Absence of standard contractual protections
• Difficulty applying a specific jurisdiction’s law

As a result, in case of disputes or losses, banks may struggle to enforce their rights.

Liability for smart contracts

Smart contracts replace traditional agreements but do not always reflect legal nuances. If there is a bug or vulnerability in the code, it may lead to financial losses.

The issue is unclear liability, which may fall on:

• Protocol developers
• Interface operators
• Users
• Or have no clearly defined party

This is critical for banks, as they remain liable to clients regardless of the source of the issue. Even if a failure occurs at the protocol level, claims are likely directed at the bank.

AML/KYC in a permissionless environment

Classic DeFi does not require user identification, while banks must comply with strict AML/KYC rules.

This creates a direct conflict:

• DeFi allows anonymity

• Banks must identify clients and monitor transactions

To address this, banks introduce additional controls:

• Using KYC-enabled interfaces
• Working through licensed intermediaries
• Restricting access to protocols

Without such measures, DeFi use may breach anti-money laundering requirements.

Custody and control over assets

In DeFi, assets are controlled through private keys, giving users full control. For banks, this model conflicts with custody and asset protection obligations.

The core issue is control allocation:

• Self-custody limits oversight
• Custodial models require licensing and compliance
• Hybrid solutions increase complexity and liability

Banks must ensure asset security even when interacting with decentralized systems, requiring additional legal and technical safeguards.

Global regulatory approach to DeFi

There is still no unified approach to DeFi regulation, but the overall trend is clear: regulators are not trying to ban the technology but to integrate it into the existing financial system. The focus is placed not on the protocols themselves, but on participants and entry points.

EU: MiCA and indirect regulation

In the European Union, crypto regulation is shaped around the MiCA framework. Traditional DeFi protocols are not directly covered, as they lack a centralized operator.

However, this does not mean an absence of oversight. The EU applies an indirect approach:

• Regulation of service providers (CASPs)
• Requirements for custody and asset management
• Control over interfaces and intermediaries

Additional focus is placed on AML through updated rules and integration with EU-wide control mechanisms.

As a result, DeFi in the EU is regulated not directly, but through the surrounding infrastructure.

United States: enforcement-driven model

In the United States, the approach is shifting from enforcement toward statutory clarity. The GENIUS Act (2025) introduced a federal framework for stablecoins, the SEC and CFTC are moving from case-by-case enforcement toward formal guidance, and the proposed CLARITY Act would allocate jurisdiction between the two agencies. A dedicated DeFi statute, however, is still pending.

Key features include:

• No single DeFi-specific law
• Active use of existing rules, including securities and derivatives law
• Regulatory pressure on front-end services and operators

In practice, even decentralized solutions may fall under regulation if there is a point of control or user interaction.

Asia: sandbox and controlled innovation

Asian financial hubs apply a more flexible approach, combining innovation with oversight.

Key models include:

• Regulatory sandboxes for testing DeFi products
• Licensing of operators and infrastructure
• Development of permissioned solutions

Jurisdictions such as Hong Kong and Singapore aim to create an environment where banks can safely use on-chain tools while remaining within regulatory boundaries.

How banks legally enter DeFi

Banks do not enter DeFi in its pure, permissionless form. Instead, they adapt the technology to regulatory requirements, building controlled and legally structured models for interacting with on-chain infrastructure.

Using regulated intermediaries

The most common approach is the use of licensed intermediaries. Banks do not interact directly with DeFi protocols but operate through regulated entities such as custodians, brokers, or specialized access providers. These participants are already within the legal framework and ensure compliance with AML/KYC requirements and asset control. This allows banks to use DeFi infrastructure without stepping outside regulatory boundaries or taking on excessive legal risk.

Permissioned DeFi

Another model is permissioned DeFi, where access to protocols is restricted to verified participants. Unlike traditional DeFi, this model introduces user identification and transaction controls. It preserves the efficiency and automation of on-chain solutions while meeting banking requirements for compliance and risk management.

Tokenized financial products

Banks also use DeFi infrastructure to issue tokenized assets. This involves moving traditional financial instruments, such as bonds, funds, or deposits, onto blockchain platforms. The legal structure remains centralized and regulated, while blockchain serves as the technological layer for settlement and record-keeping. This approach increases speed and reduces costs without sacrificing control.

Hybrid models with compliance layers

The most sustainable approach is a hybrid model in which DeFi protocols are complemented by a separate compliance layer. Control is implemented through interfaces, user access, and transaction monitoring rather than at the core protocol level. This allows banks to integrate DeFi into their existing infrastructure while complying with regulatory requirements and leveraging the benefits of decentralized technology.

Compliance requirements for banks entering on-chain finance

Entering DeFi is impossible for banks without meeting compliance requirements. Despite the decentralized nature of the technology, banks must apply the same standards as in traditional finance. This means any on-chain activity must be integrated into existing risk control frameworks.

The main challenge is that traditional DeFi protocols lack built-in regulatory compliance mechanisms. As a result, banks must add an additional control layer to ensure transparency and adherence to regulations.

In practice, key requirements include:

• Conducting AML/KYC procedures for all clients
• Complying with the Travel Rule for fund transfers
• Monitoring transactions and detecting suspicious activity
• Ensuring secure custody of assets
• Meeting reporting and disclosure obligations
• Managing sanctions risks and screening counterparties

Banks must also consider multi-jurisdictional requirements, especially in cross-border operations. This involves aligning compliance standards and adapting processes to local regulations.

Importantly, compliance in DeFi is not a one-time check but an ongoing process. Banks must not only implement controls at entry but also ensure continuous monitoring and regular updates in line with regulatory changes.

Structuring a compliant DeFi strategy

For banks, the key question is not whether to use DeFi, but how to integrate it into the existing regulatory framework. A successful strategy is built not around technology, but around risk management and legal structuring.

It is important to understand that there is no universal solution. Each model must consider the jurisdiction, product type, and level of on-chain exposure. The foundation, however, remains the same: control, transparency, and regulatory compliance.

Building a compliant strategy includes:

• Choosing the interaction model (direct access, intermediaries, or hybrid solutions)
• Structuring the product legally and defining applicable law
• Implementing crypto-agility and infrastructure control
• Conducting smart contract audits and technical risk assessment
• Integrating AML/KYC and transaction monitoring systems
• Working with licensed providers and infrastructure
• Maintaining ongoing regulatory engagement and adapting the model

Flexibility is a key element. In a rapidly evolving regulatory environment, banks must be able to adapt their solutions without fully restructuring their business.

It is also important that compliance becomes part of the product architecture. It is no longer added on top of technology but embedded at the development stage.

How Key2Law helps banks and fintech enter DeFi legally

Entering DeFi is not just a technological step but a complex legal task involving regulation, risk management, and cross-border considerations. Without professional support, companies risk sanctions, restrictions, or the need to restructure their model.

Key2Law team helps banks and fintech companies build legally sound strategies for working with on-chain finance. We support projects at every stage, from model assessment to implementation and regulatory engagement.

Our experts provide comprehensive business support:

• Analysis of the business model and applicable regulation
• Structuring DeFi products with compliance in mind
• Assessment of qualification and liability risks
• Integration of AML/KYC and transaction monitoring systems
• Support with licensing and regulatory interaction
• Structuring tokenized and hybrid models
• Management of cross-border risks
• Preparation of legal documentation and policies

If you plan to use DeFi in banking or financial activities, it is essential to design a model that meets regulatory requirements and ensures long-term stability. Contact the Key2Law team for professional support and safe integration of on-chain solutions into your infrastructure.