Authorities are seeking to close the gap in uncustodial wallets

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When it comes to storing their cryptocurrency, individuals have different choices. They can use custodial wallets (sometimes called custodial wallets), which involves middlemen (hosts) who usually receive, store, and transfer assets on behalf of their customers. For example, a centralized encrypted exchange can be a custodial wallet provider through which individuals can set up accounts/wallets. In this case, the stored value belongs to the account holder, but the funds are controlled by the wallet provider/custodian (according to contractual arrangements and customer instructions).

Alternatively, the cryptocurrency can be stored in an un-custodial wallet (sometimes called a self-custodial or non-custodial wallet), which is actually software installed on a computer, phone, or other device. The funds in a non-custodial wallet are controlled by individuals without intermediaries, similar to real cash in an actual wallet. Users of non-custodial wallets can usually interact directly with the digital currency system without the involvement of financial institutions, service providers or other intermediaries. Users of non-custodial wallets can receive, send and exchange their encrypted assets with other non-custodial wallets or on the exchange platform without revealing their identities. Naturally, transactions involving anti-custodial wallets are more difficult to track and review to achieve compliance with anti-money laundering and anti-terrorist financing.

Hostless wallets have now begun to attract more and more attention and review by authoritative institutions. Financial Crime Enforcement Network (FinCEN)-American authorities whose mission is to protect the financial system from illegal use, money laundering and terrorist financing, and to promote national security- expression The view that transactions using non-custodial wallets increase AML/CTF risks. Its concern also concerns wallets hosted by foreign financial institutions that are not subject to effective anti-money laundering regulations, such as “otherwise include wallets” from countries such as Myanmar or North Korea. The Financial Action Task Force (FATF), an intergovernmental decision-making body, has monitored and formulated international standards for AML/CTF rules, and has similar concerns.

related: U.S. updates its cryptocurrency AML/CFT laws

Although data on public blockchain networks is often open and transparent, and can be used to help track network activity, institutions like FinCEN still believe that this is not enough to mitigate the risks of unmanaged wallets.

Financial Center

In December 2020, FinCEN release A proposal called “Requirements for Certain Transactions Involving Convertible Virtual Currency or Digital Assets” has a broader purpose to address the threat of illegal financing that is believed to be caused by uncustodial or secured wallets. FinCEN recommends the establishment of new reporting and record keeping requirements, similar to traditional fund transfer rules.

The new requirements will apply to transactions involving wallets that are not covered by custody or other means, including deposits, withdrawals, exchanges and other payments made through banks or currency services or convertible virtual currencies or digital assets with legal currency status (central bank digital Currency) transfer business (MSB).

According to the proposal, if the transaction amount exceeds $10,000 (or one of multiple transactions within 24 hours, the total amount exceeds that amount), the bank or MSB must submit a report to FinCEN and provide certain information about the transaction, the counterparty (name And physical address) and verification of their customer’s identity. If the transaction amount exceeds $3,000, banks and MBS are required to keep records of the transaction and counterparty, including verifying the identity of their customers.

related: Encrypted FBAR: The meaning is not only

Task force

Soon thereafter, in March 2021, FATF release Draft guidelines for risk-based approaches for virtual assets (VA) and virtual asset service providers (VASP). It recommends that VASP treat the transactions of virtual assets in and out of the virtual host as higher-risk transactions and should be subject to strict review and restrictions.

related: The FATF draft guidance is aimed at compliance with DeFi requirements

The Financial Action Task Force also recommends that countries should understand how peer-to-peer transactions are used within their jurisdiction, as well as the potential money laundering and terrorist financing activities of such transactions. If these risks are considered to be unacceptably high, countries should focus on improving the visibility of P2P transactions and limit their exposure to risks. They can achieve this goal by issuing guidance or implementing controls, which are equivalent to currency transaction reports or cross-border tool transfer reports.

FATF pointed out very clearly that its recommendations do not place AML/CTF obligations on individuals, but on intermediaries between individuals and the financial system. Therefore, pure P2P transactions will not be subject to these obligations. However, in the case of VA transfer, for example, only one party is an obligated entity (such as VASP, and the other party is a non-custodial wallet), FATF recommends that VASP treat such virtual asset transfers as higher-risk transactions. If the transfer of virtual assets involves unmanaged wallets, FATF will effectively seek to extend the scope of travel rules to VASP.

related: Updated the guidelines of the Anti-Money Laundering Financial Action Task Force to combat money laundering and terrorist financing in Europe

If a country believes that the risks posed by P2P transactions are too high, the FATF also recommends mitigating measures, including strengthening on-site and off-site supervision, or refusing to allow VASPs that conduct transactions without custody wallets. Countries may also require VASP to only accept transactions with other VASPs, or require additional record keeping and due diligence requirements for VASPs that accept transactions with unmanaged wallets. It also instructs countries to consider other restrictions, controls or prohibitions on non-custodial wallets. VASP can choose to restrict or prohibit transactions with non-custodial wallets, or transactions with wallets that have previously conducted P2P transactions.

Beyond FinCEN and FATF

FinCEN and FATF are not the only institutions trying to close the gap in hostless wallets. For example, Switzerland and the Netherlands have imposed stricter controls.

The Swiss Financial Market Supervisory Authority has Impose stricter requirements on transactions A personal wallet of more than 1,000 Swiss francs (approximately US$1,020). These requirements include identifying a party, establishing a beneficial owner and verifying the party’s right to dispose of the external wallet.

In the Netherlands, the Dutch National Bank (DNB) now requires that encryption service providers who wish to formally register with the central bank must Prove that they meet the verification requirements According to the “Sanctions Act” of 1977. It involves determining the identity and residence of the counterparty, screening it against the sanctions list, and determining that the person or legal person is actually the recipient or sender. This additional request has been criticized a lot and is now being challenged in court.

Takeaway

FinCEN and FATF seem to have aligned their methods with uncustodial wallets. Their proposal has not yet been finalized, and has been heatedly debated and criticized. The FinCEN proposal alone received more than 7,700 comments. Initially, FinCEN controversially only allowed 15 days to comment, justifying its short consultation time and its foreign affairs functions, important national security requirements, and previous contacts with the cryptocurrency industry. However, in mid-January 2021, FinCEN Reopen The comment period is an additional 15 days for reporting requirements, and 45 days for record keeping and counterparty reporting obligations. By the end of January 2021, FinCEN has further extended the comment period by 60 days; the comment period ended on March 29. On the other hand, the FATF’s consultation period ended on April 20.

Stakeholders have raised many concerns, including legal, procedural, technical and ethical issues. There is a privacy issue, because discovering an identity after an unmanaged wallet will reveal the entire transaction log recorded on the public network, which goes far beyond the information collected in traditional banking transactions based on travel rules. The new rules will make service providers assume additional compliance obligations related to non-client parties, and will also force individuals to disclose personal information to their counterparty service providers. Some service providers are unlikely to choose not to support transactions without custodial wallets to avoid additional compliance burdens, which will actually constitute an indirect prohibition of such transactions.

There are still many technical and operational problems in the implementation of these requirements. For example, DNB recommends solutions for screening counterparties, including screen sharing or video conferencing when logging in, signing transactions or returning a small amount of cryptocurrency to the provider upon request, all of which alone cause many problems and seem to be infeasible.

The new rules may also undermine financial inclusion, because uncustodial wallets provide access to financial services for people who do not have a bank account or have insufficient bank accounts. Strict control of uncustodial wallets will also complicate matters such as charitable fundraising in cryptocurrencies, because charitable organizations cannot control who makes donations, and donors usually want to remain anonymous.

As a cryptocurrency market Standing After the recent incredible bull market, the company’s market value is approximately US$2 trillion, and other compliance requirements are at stake. Stakeholders are eagerly looking forward to the final decision of FinCEN and FATF.

The views, thoughts and opinions expressed here are only the author’s own, and do not necessarily reflect or represent the views and opinions of Cointelegraph, Warsaw University of Technology or its affiliates.

This article is for general reference only and is not intended and should not be regarded as legal advice.

Agata Ferreira He is an assistant professor at Warsaw University of Technology and a visiting professor at many other academic institutions. She researches law in four different jurisdictions under common law and civil law systems. Agata has practiced in the UK financial industry for more than ten years in a leading law firm and an investment bank. She is a member of the expert panel of the European Blockchain Observatory and Forum, and a member of the European Blockchain Advisory Committee.

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