Decentralized Finance and Financial Regulation: Limits On Mutable Turing Machines

Abstract

Our study combines financial regulation and computer science concepts to identify which decentralized finance architectures allow meaningful regulations. We show via deduction that a decentralized and permissionless Turing-complete system cannot provably comply with existing financial regulations related to anti-money laundering (AML) and know-your-client (KYC) obligations. Any system that claims to follow regulations must choose either a form of permission or a less-than-Turing-complete update facility. Compliant decentralized systems can be constructed, but only by compromising on the richness of permissible changes. Regulatory authorities must accept new trade-offs that limit their enforcement powers if they want to approve the use of permissionless platforms formally.

Keywords: decentralized finance, financial regulation, Turing machines, anti-money laundering, know-your-client

JEL Classification: G28, K24, O33