DeFi protocols don't have KYC/AML systems. All they know about is your wallet, and from that wallet you can buy any token, borrow/lend, add liquidity to a market-maker pool, etc.
The goal of regulators should be to stop people from taking advantage/scamming others, not to stop innovative financial products from being built.
Defi protocols (at least on eth) are open source, so I can verify that they are doing what they are supposed to be doing and use those products. It would be far from ideal if some regulator decided that we can't use it because reasons x,y,z.
Regulators have far broader scope for regulation than just to ensure that people are not taken advantage of or scammed.
They don't stop innovative financial products from being built, they might stop them from being used for a particular purpose or even at all depending on how a particular development impinges on the list of items for which they regulate.
Amongst others, and depending on where you live your local regulators may add or subtract from this list considerably:
That list was developed for traditional finance. After messing around with DxDy protocol, i learned that literally all of those point are impossible. Also, how would you shut them down if they don't comply - It's a smart contract on eth. Even if you arrested everyone involved, it 'lives' outside of the reach of the US gov unless you ban all of eth.
The company I work for is owned by a huge French bank. Even though I am in tech I still need to do some mandatory (legally required) training, and one of the courses is Treating Customers Fairly.
The FCA say "Treating customers fairly is a requirement for all regulated firms, no matter their size or the nature of the activities they undertake".
Sure, but we also live in a free society, so they can't just ban things because they feel like it without swift opposition. If it's a legitimate thing that people want, it'll still continue to exist, but would only move underground (for example, we know how alcohol ban worked out).
Defi protocols (at least on eth) are open source, so I can verify that they are doing what they are supposed to be doing and use those products. It would be far from ideal if some regulator decided that we can't use it because reasons x,y,z.