Risks and Regulatory Paths of Blockchain-based Decentralized Finance

Authors: Deng Jianpeng (Professor and Doctoral Supervisor, School of Law, Central University of Finance and Economics; Director of the Financial Technology Law Research Center), Zhang Xiaming; Source: *World Social Sciences*, 2025, No. 5

Abstract

Based on smart contracts, Ethereum has pioneered a new paradigm for decentralized finance (DeFi). However, DeFi harbors various risks, impacting traditional financial regulatory mechanisms, raising numerous legal issues, and posing challenges to financial law and regulation. The US government's sanctions against the DeFi application Tornado Cash marked a watershed moment in the regulation of DeFi, sparking significant legal controversy, and the subsequent court rejections of the sanctions had a profound impact. The mainstream regulatory models for DeFi are repressive and responsive. The US sanctions against Tornado Cash under the responsive model have raised controversies regarding exceeding authority, violating due process, and imposing excessively harsh penalties, while also raising market concerns about the vulnerability of the DeFi ecosystem.

my country should timely shift its regulatory approach to decentralized finance (DeFi) applications, penetrating the "veil" of DeFi and optimizing its responsive regulatory model. Based on this, it should clarify the attributes of key infrastructure such as smart contracts and formulate standards; strengthen the regulation of nodes, using centralized nodes such as stablecoins as a powerful tool for DeFi regulation; regulate DeFi using anti-money laundering as a starting point, and reasonably determine the legal nature of the related behaviors of smart contract protocol developers; emphasize the balance between privacy protection and financial security; enhance extraterritorial jurisdiction and enforcement capabilities to fully address the potential negative impacts of DeFi and improve my country's comprehensive capabilities in developing fintech and digital finance. I. Introduction: Financial Paradigm Shift and Regulatory Dilemmas Under the Digital Wave We are standing at a historical juncture where digital technology is profoundly reshaping the global financial landscape. Crypto assets built on blockchain technology—from Bitcoin, a pioneer in value storage, to stablecoins attempting to anchor to real-world value, and non-fungible tokens representing the assetization of everything—and the vast financial innovation ecosystem derived from them, are emerging and iterating at an unprecedented pace. In this wave, decentralized finance (DeFi) is undoubtedly the most disruptive and cutting-edge representative. It aims to utilize smart contracts and distributed networks to build a global, open, and transparent financial operating system that does not rely on centralized intermediaries such as traditional banks, securities firms, and insurance companies. This "financial Lego"-like revolution not only challenges the financial intermediation model that has existed for centuries but also has a profound impact on the financial technology legislation, regulatory frameworks, and judicial practices of countries around the world. However, compared to the rapid global development of DeFi, related research in domestic academia presents a complex situation. Existing domestic research on public blockchains (the most dynamic and challenging form of blockchain) largely focuses on the regulatory governance of private cryptocurrencies, the characterization of crypto assets in judicial practice, cryptocurrency crimes from a criminal law perspective, and the legal risks posed by centralized trading platforms. In the more native DeFi field, research on systematic and comprehensive industry risk assessment and regulatory pathways remains weak. While some scholars have proposed strengthening industry self-governance, such as through collaborative regulation in areas like user identification, anti-money laundering, and counter-terrorist financing, to compensate for current regulatory shortcomings, the feasibility of this suggestion in the highly anonymous and globalized DeFi practice is questionable. This research bias does not stem from a deliberate neglect of public blockchains by academia, but is largely influenced by the cautious policy environment adopted by my country since 2017 regarding the cryptocurrency sector, ranging from risk warnings to "ban-like" regulations. However, it must be clearly recognized that DeFi applications built on public blockchains are inherently global, borderless, and censorship-resistant. They will not cease to function due to bans by a single sovereign state. Therefore, research on the legal regulation of DeFi not only has theoretical value in clarifying new legal relationships but also has a practical urgency in safeguarding national financial security and strategic interests. The Central Financial Work Conference held in October 2023 elevated "accelerating the construction of a strong financial nation" and "adhering to full coverage of financial supervision, bringing all financial activities under regulation" to an unprecedented strategic level. Against this backdrop, exploring how to effectively regulate DeFi, a new type of financial activity, is an inevitable requirement for ensuring national financial security and stability, effectively preventing systemic financial risks, and protecting the legitimate rights and interests of investors. It is also a practical need to promote the steady and long-term development of my country's digital finance and fintech, maintain financial market order with strict and fair rule of law, and improve the modern financial regulatory system. This article will focus on a landmark event—the US sanctions against the Tornado Cash mixing protocol and subsequent legal proceedings. Using this as a lens and case study, we aim to deeply analyze the inherent risks and external challenges of DeFi, systematically examine the applicability and limitations of existing financial regulatory theories in dealing with such innovations, and, based on this, combine the latest developments in global regulatory practices to provide forward-looking and feasible insights into China's governance path in the digital finance era. II. A Comprehensive Overview of DeFi Risks: Why Tornado Cash Became the Eye of the Storm? 1. The Essence of DeFi: A Technologically Driven Financial Paradigm Revolution To understand its risks, we must first clarify its essence. DeFi is not simply the online version of financial products, but a completely new financial paradigm. It uses crypto assets and public blockchains (such as Ethereum) that support smart contracts as its infrastructure, automating various financial services such as cryptocurrency trading, lending, insurance, derivatives, and asset management through a series of composable and interoperable smart contracts. Its core characteristic is "disintermediation" or "non-custodial," meaning that users always control their own asset private keys and complete financial activities by interacting with code rather than centralized institutions. This paradigm offers significant advantages: it drastically lowers the barriers to accessing financial services globally. Its distributed, trustless, flat, open, transparent, and composable characteristics theoretically improve financial efficiency, reduce service costs, optimize resource allocation, and accelerate the market transformation of blockchain technology innovation. As of June 2024, the total value locked (TVL, which can be considered the assets under management) of over 2,000 DeFi applications worldwide reached $105.85 billion, peaking at over $147.8 billion. It has become an indispensable innovative force parallel to and interconnected with the traditional financial system. Tornado Cash (TC) is a key application within this vast DeFi ecosystem, focusing on solving a specific pain point—transaction privacy. Because the ledger data of mainstream public chains such as Bitcoin and Ethereum is completely publicly verifiable, the transaction history and balance of any address are transparent to the entire network, undoubtedly exposing users' financial privacy. Mixer protocols have emerged to address this, and TC is one of the largest and most representative examples. It is a decentralized, non-custodial smart contract protocol. Users deposit mainstream cryptocurrencies (such as ETH) into TC's smart contract "liquidity pool" and receive a credential (zero-knowledge proof). They can then withdraw the same amount of funds using a completely new, unrelated address, effectively severing the on-chain link between the deposit and withdrawal addresses, achieving transaction path obfuscation and privacy protection. Statistics show that in the first half of 2024, the TC protocol received $1.9 billion in user deposits, a 50% increase compared to the entire year of 2023, demonstrating its strong market demand. 2. The Dual Risk Map of DeFi: Internal Governance Dilemmas and External Negative Impacts While DeFi paints a rosy picture of a financial utopia, the risks it exposes in practice are equally complex and severe, which can be summarized into two levels: internal and external. Internal Risks: The Governance Illusion and Centralized Power under "Code is Law" In theory, DeFi projects are governed through Decentralized Autonomous Organizations (DAOs), where all governance token holders vote collectively to achieve "code democracy." However, reality is often harsh. Governance tokens are typically highly concentrated in the hands of founders, core teams, and venture capital firms early in the project's life. These "whale" investors effectively control the protocol's fate. They can use their massive voting power to push proposals that benefit themselves rather than the community, and even unilaterally change core protocol parameters. This makes DeFi governance highly susceptible to becoming a "fake democracy, real dictatorship," where so-called community governance becomes a facade controlled by a few insiders, leading to serious agency problems and moral hazards. External Risks: Systemic Risks and the Shadow of Criminal Tools This is the most criticized aspect of DeFi by regulators, mainly reflected in: 1. An amplifier of money laundering and terrorist financing risks: The U.S. Treasury Department has repeatedly pointed out that DeFi is becoming a "cash cow" for crypto hackers and a "revolving door" for illicit funds. According to a report by blockchain data analytics company Chainalysis, by 2022, DeFi protocols had become the largest recipient of illicit funds, accounting for 69% of all funds transferred out of criminal addresses. Because most DeFi protocols lack a clear, regulated controlling entity (such as Virtual Asset Service Providers (VASPs), they are often not directly bound by traditional anti-money laundering and counter-terrorist financing rules. Privacy-enhancing tools like TC, through technical means, obfuscate the source and destination of funds, making it exceptionally difficult for law enforcement agencies to verify user identities, track transactions, collect evidence, and recover illicit funds. This significantly increases the concealment and urgency of money laundering crimes, posing a direct threat to national financial security. 2. Technical Risks and Smart Contract Vulnerabilities: If a smart contract deployed on the blockchain has code vulnerabilities, it can be exploited by hackers, leading to the instant theft of user assets. Due to the irreversibility of transactions, losses are often difficult to recover. 3. Transmission of Systemic Risks: The high composability within the DeFi ecosystem acts like a domino effect. The failure of a core protocol (such as stablecoin de-pegging or the liquidation of a large lending protocol) can trigger a chain reaction throughout the entire ecosystem through liquidity locking and asset linkage.

3. The Typicality and Research Value of the Tornado Cash Case

This paper selects the Tornado Cash sanctions case as the entry point for studying DeFi regulation, based on its multiple typical significances:

1. Industry benchmark and technological representativeness: TC is the largest and most influential cryptocurrency mixer in the blockchain ecosystem, running on 7 different blockchains, supporting mixing services for 10 mainstream cryptocurrencies, and possessing the largest privacy asset pool. Its zero-knowledge proof technology represents the cutting-edge direction of blockchain privacy protection.

2. Risk focus: The TC case vividly demonstrates the most prominent external risk of DeFi—money laundering. Research shows that in the first half of 2022, 74.6% of money laundering funds in blockchain security incidents flowed to TC, amounting to over 300,000 ETH.

A U.S. Treasury Department investigation revealed that over $7 billion worth of illicit cryptocurrencies have been laundered through the TC since its inception. This makes it an excellent case study for observing the risks and regulatory conflicts within DeFi. 3. Regulatory Innovation: The U.S. Treasury Department's Office of Foreign Assets Control's sanctions against the TC in August 2022 marked the first time a major global government had directly sanctioned a "decentralized" smart contract protocol itself, shattering the myth that DeFi was "unregulatory" and ushering in a new era of DeFi regulation. Subsequent partial court rejections of the sanctions sparked a global debate on the boundaries of administrative power, technological neutrality, and civil rights. 4. Academic Inspiration: This case forced legal research to move beyond superficial analysis of DeFi, arguing that regulatory strategies for consortium blockchains or centralized platforms cannot be simply applied to DeFi based on public blockchains. It requires scholars to delve into the core technology, understanding the operational logic of core elements such as smart contracts, DAOs, and zero-knowledge proofs, in order to propose more targeted and operational regulatory solutions. The rise of DeFi poses a structural challenge to the traditional regulatory system based on centralized financial models. Issues such as unclear regulatory bodies (who should be regulated?), the abstract nature of regulatory targets (protocols have no physical form), the failure of regulatory tools (code runs automatically globally), and the lack of consumer protection mechanisms (who to turn to when problems arise?) have become prominent. At the theoretical level, two main modes of response have emerged. Repressive Regulatory Model: Risk Isolation Dominated by Power This model takes the public interest as its ultimate goal and uses the unilateral, coercive administrative actions of the government as its primary means. In the blockchain finance sector, this typically manifests as strong intervention by public power, using regulations, policies, or internal directives to impose blanket bans, maintaining a high-pressure stance at the law enforcement and judicial levels. my country currently adopts a similar model for DeFi and related cryptocurrency businesses. Its advantage lies in its ability to quickly isolate risks and prevent their spread to the traditional financial system. However, scholars have also pointed out that prohibitive regulation cannot effectively protect the legitimate property rights of digital currency holders; instead, it may suppress competition and innovation, while driving more transactions into the underground gray area, ultimately exacerbating the transformation of individual risks into group and social risks. In practice, this regulatory approach is not entirely effective as a firewall, and it may undermine the legitimacy of the prohibition mechanism when faced with the ex-post compensation demands of dispersed investors. Responsive Regulatory Model: Flexible Governance Centered on Collaborative Adaptation This model requires legal and financial regulation to proactively adapt to the profound changes in the technology and finance sectors, acknowledging the significant incompleteness of the legal system brought about by technological and financial innovation in modern society. It advocates for reform and responsiveness of the rule of law to fully unleash the self-regulatory potential of different social systems (including the technology community). Some scholars, after comparing the digital finance regulatory models of the EU and the US, have pointed out that the US, under the label of "smart regulation," is gradually forming an adaptive, non-systematic regulatory model characterized by iteration, flexibility, risk sensitivity, and innovation friendliness. This model not only better aligns with the regulatory needs of rapidly developing fintech, but also resonates to some extent with the "co-construction, co-governance, and sharing" operating philosophy advocated by DeFi. While the US sanctions against TC are forceful, they are based on a detailed investigation of protocol risks, fund flows, and related entities, demonstrating a "proactive response" to the risks of the DeFi ecosystem, rather than simple neglect or avoidance. IV. A Comprehensive Analysis of US Sanctions Against Tornado Cash: Practice, Reversals, and Deep-seated Controversies 1. A "Combination Punch" of Sanctions: From Agreement-Based Bans to Criminal Accountability The US has employed its powerful financial governance tools to impose a series of increasingly stringent "combination punches" of regulations on TC: Phase One: Financial Sanctions at the Agreement Level (August 2022) The U.S. Treasury Department's Office of Foreign Assets Control (OFAC), citing authorizations under the International Emergency Economic Powers Act (IEEPA), has added the tornado.cash website, 37 TC smart contract addresses (including at least 20 immutable contracts), and a donation address to the "Specially Designated Nationals List" (SDN List). This means that any U.S. citizen, permanent resident, or entity located in the U.S. is prohibited from engaging in any transactions with these listed "entities," or their assets and property interests in the U.S. will be frozen. This order immediately triggered an industry upheaval: GitHub, the open-source code hosting platform, banned TC developer accounts; Gitcoin, the Ethereum open-source incentive platform, stopped grants; Circle, the centralized stablecoin issuer, froze USDC assets in the sanctioned addresses; and various node service providers (such as Infura and Alchemy) and decentralized application wallets (such as Metamask) also blocked relevant front-end interfaces. The U.S. government, through the key "access points" of the sanctions agreement, has effectively "encircled" decentralized protocols. Phase Two: Criminal Charges Against Individuals (August 2023) One year after the sanctions imposed under the agreement, the U.S. Department of Justice filed criminal charges against Roman Storm and Roman Semenov, the two founders of DeFi protocols, and Alexei Pertsev, a core developer, for conspiracy to launder money, violating IEEPA, and conspiring to operate an unlicensed money transfer business. In May 2024, Pertsev was the first to be sentenced to five years and four months in prison by a Dutch court (due to his arrest in the Netherlands). This case signifies that the founders and core code developers of DeFi protocols are now being brought under the purview of traditional criminal law and facing serious criminal risks. 2. Dramatic Reversal: Judicial Checks and Balances on Executive Power On November 26, 2024, the case took a major turn. The U.S. Fifth Circuit Court of Appeals ruled, partially overturning the Treasury Department's sanctions decision against TC. The core logic of the court's ruling was: Smart Contracts Are Not "Property": The court held that TC's smart contracts are immutable code programs deployed on a public blockchain, which cannot be owned, controlled, or modified by anyone (including their developers). Therefore, they do not fall under the definition of "property of a foreign national or entity" as defined by IEEPA. Incorrect Target of Sanctions: Since smart contracts themselves are neither "property" nor "entities" in the legal sense, OFAC's inclusion of them on the SDN list constitutes an overinterpretation of legal authority and an overreach of jurisdiction. Protecting Innovation and Freedom: This ruling emphasizes the importance of protecting privacy, innovation, and financial freedom in the blockchain space, clarifying the limits of legal authorization that administrative power should adhere to when facing new technologies. It is considered a significant judicial victory for the open-source software and crypto industry. 3. The Effectiveness of Regulation and the Deep Legal Controversies It Causes Effectiveness Analysis: Deterrence and Limitations Coexist The sanctions produced a powerful chilling effect in the short term: the total locked value of TC fell by about 12% within two days of the sanctions, and the price of its governance token TORN plummeted by about 40%; the global open-source community felt deeply insecure, and developers worried about being held accountable for their code. However, in the long run, the effectiveness of the sanctions is greatly reduced. Because the core, immutable smart contracts cannot be shut down, users can still interact with the protocol by deploying nodes themselves. Blockchain data shows that even after sanctions, TC remains the most active mixer on Ethereum, with deposits even showing a significant increase against the trend in the first half of 2024, exposing the limitations of simply blocking fully decentralized protocols. Four Core Legal Controversies: 1. Issues of Excessive Jurisdiction and Target Eligibility: The focus of the controversy is whether OFAC exceeded the authorization of IEEPA. Critics (such as the cryptocurrency think tank Coin Center) argue that smart contract protocols and addresses are not "individuals" or "entities" in the literal sense of IEEPA; developers are merely providing "simple software development services," not engaging in "fund transfer business." Treating uncontrollable code as a target of sanctions lacks a legal basis. The Fifth Circuit Court of Appeals upheld this view. 2. Due Process and Violation of Fundamental Rights: Sanctions imposed without adequate impact assessment and hearings, restricting U.S. citizens' right to use a particular internet tool, were deemed a violation of the Due Process Clause of the Fifth Amendment to the U.S. Constitution. Simultaneously, the ban on privacy agreements was also questioned for violating the First Amendment's protections of freedom of speech (code as a form of expression) and the right to privacy. 3. Controversy over Subjective Intent in Criminal Prosecution: The Department of Justice's indictment of the founders and developers on charges of "conspiracy to launder money" faces significant legal challenges. The core issue is how to prove that the technology developers had the subjective intent to "conspire." If the developers aimed to provide privacy-protecting technology and had no criminal intent with illegal users, would considering them as accomplices in money laundering violate the principle of consistency between objective and subjective intent in criminal law? This involves exploring the boundaries of the principle of technological neutrality. 4. Exposing the "Achilles' heel" of the DeFi ecosystem: The sanctions clearly reveal that DeFi is not a monolithic decentralized system. It heavily relies on a series of centralized or quasi-centralized nodes, such as stablecoin issuers (Circle), front-end service providers (Infura), and code hosting platforms (Github). When public authorities exert pressure on these "choke points," the usability of DeFi applications is severely impacted. This provides a practical tool for regulation and has triggered profound reflection within the industry on reducing reliance on centralization. 4. A Further Summary of US Regulatory Experience This confirms the regulatory nature of DeFi: While fully decentralized core protocols are difficult to eradicate, centralized nodes within its ecosystem can be effectively regulated. The right to set rules is a strategic high ground for future competition: Through this case, the US is essentially conducting a "stress test" of its DeFi regulatory model globally, vying for the right to define rules and have a voice in this field. Responsive regulation must adhere to the rule of law: Even when proactively responding to risks, any regulatory measures must be legally grounded and procedurally due. The discretionary power of administrative agencies cannot be expanded indefinitely; judicial review is a necessary balancing mechanism. Over-regulation stifles innovation, while under-regulation fosters risk; finding a balance is a perpetual theme. V. Implications, Challenges, and Path Optimization for China: Building a Future-Oriented Fintech Governance System 1. Theoretical Implications: Governance Wisdom from "Blocking" to "Guiding" Piercing the Veil of "Decentralization" to Implement Precise Regulation The TC case proves that DeFi is not absolutely unregulated. Regulatory authorities should adhere to the principle of "substance over form," penetrating the technological facade of "decentralization" to identify and target the various centralized elements hidden behind it. These include: identity elements (founders, core developers, whale users), organizational elements (DAO core members, codebase maintainers, node service providers), asset elements (key stablecoins), and activity elements (illegal on-chain financial activities). The U.S. Treasury Department indirectly and effectively influenced the operation of the TC protocol by sanctioning developers and pressuring stablecoin issuers and front-end service providers. Optimizing the regulatory model and evolving towards an inclusive and prudent "responsive regulation" approach. my country should reflect on and optimize its current regulatory approach, which is primarily based on "blocking." Any blanket ban is as inappropriate as trying to regulate cars with horse racing laws; it not only fails to address the problem but may also accelerate the lag in legislation, weakening the legitimacy and effectiveness of regulation. A shift in mindset is needed: acknowledging the progressiveness of the technology and concepts represented by DeFi, while effectively separating the technology itself (neutral code) from illegal activities using it. Technical architecture can be regulated through standards and guidelines; risky behaviors should be severely punished according to law. Strengthening Dialogue and Collaboration: Regulators should proactively communicate with developers, investors, and auditing firms in the DeFi field to understand its operational logic and real risks. While upholding the bottom line of preventing systemic financial risks, they should reserve flexibility for responsible innovation. The US court's rejection of sanctions against TC is a correction to excessive administrative intervention, protecting the space for innovation and is worth learning from. Adhering to the Rule of Law: Substantively, regulation must be conducted within legal authority; smart contracts should not be arbitrarily interpreted as "entities" or "property." Procedurally, the principle of due process must be followed, guaranteeing the parties' right to know, participate, and seek redress, ensuring the balance and appropriateness of regulatory measures, and strictly adhering to the principle of proportionality. 2. Unique Challenges and National Constraints Faced by China However, the US regulatory model cannot and should not be copied to China. We face unique challenges: Limited Extraterritorial Jurisdiction: Many core DeFi teams are located overseas, allowing the US to pursue accountability through "long-arm jurisdiction," while Chinese regulators find it difficult to effectively reach them. The Systemic Advantage of the "Digital Dollar": The current lifeblood of DeFi—stablecoins (such as USDT and USDC)—is essentially an extension of the dollar system. China lacks digital currency tools with equivalent global influence for hedging and regulation.

Ambiguous Legal Liability: The legal status of DAOs is unclear, and the boundaries of civil and criminal liability for smart contract developers under current laws are extremely blurred, posing significant difficulties for law enforcement and the judiciary.

Global Regulatory Capabilities Need Improvement: Effective global regulation requires strong discourse power, advanced on-chain analysis technology, a sound international law enforcement cooperation network, and a corresponding domestic legal system. my country still has a long way to go in building its capabilities in these areas.

3. Optimization of China's Financial Regulation Path: Six Strategic Measures

Based on the above analysis, my country can consider adopting the following gradual optimization path:

1. Clarify Legal Attributes and Implement a Standards-First Strategy

Legal Characterization: It is urgent to clarify the legal attributes of DeFi core elements such as smart contracts, DAOs, and stablecoins at the legislative level. For example, immutable smart contracts, due to their uncontrollability, should not be considered "property"; while mutable contracts that can be controlled by a specific entity may be considered property or legal acts.

Developing National Standards: A national standards development committee could take the lead, in conjunction with industry experts, to release documents such as the "Operation Guidelines for Key Financial Infrastructure of Smart Contracts," unifying programming specifications, security audit standards, privacy protection requirements, and dispute resolution mechanisms for smart contracts. This would embed compliance elements into the code development stage, achieving flexible governance through "regulation via code."

2. Controlling Key Nodes, Using Stablecoins as a Strategic Breakthrough

Qualitative Regulation of Stablecoins: Stablecoins pegged to a single foreign currency would be explicitly included in the broad category of "foreign currency securities" or foreign exchange assets, and would be subject to regulation under the existing foreign exchange management and anti-money laundering framework.

Developing RMB stablecoins: Actively support the exploration of issuing compliant stablecoins pegged to offshore RMB or HKD in compliant jurisdictions (such as Hong Kong). This is not only a strategic move to counter the hegemony of the "digital dollar," but also a tool to monitor related DeFi activities and enhance my country's influence in the digital finance sector. Hong Kong's Stablecoin Bill, passed in 2025, already provides a regulatory framework that can be referenced. 3. Prioritizing Anti-Money Laundering and Precisely Defining Technical Responsibilities. Utilizing New Legal Authorization: The revised Anti-Money Laundering Law of 2024 added protective jurisdiction clauses, providing a legal weapon for regulating overseas DeFi money laundering activities that harm my country's financial interests. Introducing Regulatory Technology: Connecting to public blockchains through sidechains, Layer 2, and other technologies, deploying on-chain monitoring systems, and marking and tracking high-risk addresses. Accurately Distinguishing Between Crime and Non-Crime: This is the core key. For smart contract developers, it is crucial to strictly distinguish between technology-neutral development activities and complicity in crime. If developers aim for technological innovation, fulfill reasonable due diligence (such as third-party security audits and setting user whitelists), and the technology has legitimate application scenarios, then criminal liability should be avoided. Conversely, if their actions clearly serve illegal purposes, they may be considered accomplices in aiding and abetting cybercrime or money laundering. 4. Seeking a Dynamic Balance, Balancing Privacy Protection and Financial Security. Regulators must recognize that the right to privacy is a fundamental right of citizens, and code development is a form of freedom of speech. While combating crime, technological innovation that protects privacy should not be stifled. All regulatory measures should adhere to the principle of proportionality in a narrow sense, ensuring that the infringement on individual rights is proportionate to the pursued public interest, avoiding excessive regulation that is "using a sledgehammer to crack a nut." 5. Enhance extraterritorial jurisdiction and actively participate in shaping international rules. Innovate jurisdiction theory: In legal theory, we should actively explore extraterritorial jurisdiction based on "real connection" and "legitimate interests," such as using "the place where the tortious act has an impact," "the location of the key service provider," and "the location of the victim" as connecting points. Promote the construction of a system for the extraterritorial application of domestic law: Improve the extraterritorial application mechanisms of laws such as financial law, criminal law, and anti-money laundering law. Strengthening International Cooperation and Rule-Making Leadership: Actively participate in the formulation of DeFi regulatory standards by international organizations such as the Financial Action Task Force (FATF), and promote the internationalization of my country's regulatory standards. A powerful nation is one that can export rules and provide international legal public goods. Strengthening Capacity Building and Cultivating a Technology-Driven Regulatory Team: Regulatory agencies must achieve digital transformation themselves, cultivate and attract compound talents who are proficient in both blockchain technology and financial law, establish professional on-chain data analysis teams, shift from passive response to proactive early warning, and comprehensively improve the regulatory effectiveness for new financial formats such as DeFi. VI. Conclusion The US sanctions against Tornado Cash, like a meticulously orchestrated stress test, provide an excellent perspective for a comprehensive examination of the inherent risks and regulatory logic of decentralized finance (DeFi). This case clearly reveals that while DeFi brings efficiency and innovation, it also carries significant governance flaws and the risk of being used for illegal activities; it is not a lawless zone, and the "re-centralized" nodes embedded within its ecosystem offer a realistic possibility for effective regulation; however, any regulatory action must adhere to the rule of law and balance multiple values ​​such as security, innovation, and rights protection, otherwise it will face questions of legitimacy and discounts on effectiveness. This game between the US administrative, judicial, and technological communities has already transcended national borders. It is not only an important pawn in the US's struggle for global digital finance rule-making power by leveraging its financial strength and technological influence, but it also poses a potential challenge to the judicial sovereignty and financial security of other sovereign states. Currently, major countries and regions around the world are actively exploring ways to regulate DeFi, especially given the backdrop of the Trump administration's explicit embrace of crypto assets after taking office in the US in 2025, intensifying global institutional competition. In this unprecedented global transformation, China cannot be absent. We must re-examine and optimize our own regulatory path with a high degree of strategic vision and a sense of urgency. We must shift from simple "ban-style" isolation to building a future-oriented intelligent regulatory system centered on "standards first, node control, functional definition, balanced governance, and international cooperation." Only in this way can we effectively prevent and resolve financial risks, seize the historical opportunities of digital finance development, continuously improve modern financial regulatory theory, enrich China's financial policy practices, and ultimately occupy a favorable position in the upcoming new global blockchain financial landscape, laying a solid foundation of rules and strength for achieving the great goal of becoming a "financial power." The road ahead is full of challenges, but proactive exploration is far more likely to win the future than passive response.