What’s Happening:
The US Treasury officially withdrew a rule proposed in 2020 by FinCEN, the Financial Crimes Enforcement Network. The rule would have:
- Subjected individuals using unhosted, or self-custodial, wallets to requirements that would ultimately ban peer-to-peer digital asset transactions, decentralized finance (DeFi), particular NFT platforms, and other decentralized or peer-to-peer activities.
- Required self-hosted wallet users to collect and report on counterparty information for each transaction they participate in.
The reporting requirements are technically impossible in most cases. Since blockchain wallet addresses are pseudonymous, users can trust the transactions and their counterparties without knowing or being able to learn personally identifiable information that this rule would have required for reporting purposes. This innovative design not only sets blockchains apart from traditional financial and data transfer technologies, but also makes it prohibitively difficult for users and developers to collect counterparty information outside of centralized platforms. Similar legislative and regulatory efforts to “ban” self-hosted wallets and non-centralized activities in other jurisdictions, such as the European Union, have also been unsuccessful in previous legislative efforts. However, with EU legislators discussing updates to their Markets in Crypto Assets (MiCA) Regulation, this issue may be renewed in that region.
Background:
TDC has been deeply involved in supporting the U.S. Treasury’s decision to withdraw the proposed rule on self-custodial wallets. We started by sending a detailed letter to Secretary Mnuchin, expressing our serious concerns about how the rule would impact digital asset innovation and individual privacy. Recognizing the urgency, we also launched a petition to stop the last-minute rulemaking, mobilizing support from both industry leaders and the general public. Our thorough analysis of the proposed rule highlighted potential negative effects on the digital assets sector, advocating for a more balanced regulatory approach. In our response to FinCEN’s Notice of Proposed Rulemaking (NPRM), we reiterated these concerns, arguing that the rule would unfairly burden users of self-hosted wallets without providing clear benefits. Through these concerted efforts, we played a key role in the Treasury’s decision to retract the proposal, underscoring our commitment to shaping fair and effective regulatory policies for digital assets.
Why it Matters:
The rule was part of a broader effort to apply the same Know-Your-Customer and Anti-Money-Laundering rules from traditional finance to crypto. While The Digital Chamber strongly supports efforts to eliminate fraud and illicit finance in crypto, the would-be application of this rule does not meet these policy goals. Instead, it would force virtually all crypto activity outside centralized exchange platforms to cease. Moreover, blockchain analytics reports continue to show that illicit finance and money laundering in crypto account for less than one percent of overall transaction activity (see TRM Illicit Crypto Economy report). The application of this rule would have had outsized harm to the industry in exchange for microscopic progress toward its policy objective, when measuring total transaction volume.
Key Points:
Counterparty reporting requirements are rigorously enforced in traditional finance and by centralized crypto platforms, where they serve their intended purpose. However, these requirements do not fully address the policy objectives they were designed for, as fraud and money laundering in traditional finance are in the trillions of dollars. In contrast, blockchain systems offer full transaction transparency, making it easier to trace and catch illicit activities. Traditional financial networks, on the other hand, often lack transparency; cash transactions, fraudulent accounts, scams, terrorist financing, and money laundering activities are not always visible to regulators and law enforcement. Applying the same regulations in traditional finance that do not fully meet intended policy objectives to crypto transactions and individual users is a suboptimal method of stopping crime and protecting consumers, at best.
Our Perspective
“The Digital Chamber strongly supports technical efforts, legislation, and rules that meet the critical policy objectives of combatting fraud and illicit transactions and protecting consumers. However, this rule would have brought large parts of the industry to a halt. We applaud the Department of the Treasury for recognizing that there are ways of achieving these policy objectives in the crypto ecosystem that will allow the industry to live on and innovate. It will become safer and more secure as it does so. We look forward to working with policymakers and industry to create these better-fitting policy and technical solutions.” – Jonathan Rufrano, Policy Director, The Digital Chamber.