Law Decoded: ‘Unhosted’ wallets are just ‘wallets,’ March 28–April 4

Yet another regulatory attack on self-hosted wallets, a digital dollar with privacy protections, and more of the same for spot BTC ETFs.

The European Parliament continued to keep crypto users and advocates at the edge of their seats last week as yet another piece of potentially harmful legislation — this time, a set of demanding data disclosure requirements for digital asset service providers — was rushed to a vote mere days after a near miss on banning proof-of-work-based cryptocurrencies. 

Unlike the relatively happy resolution of the Markets in Crypto Assets framework situation, the EU’s new Anti-Money Laundering rules retained all the crypto-hostile language as they are going into the next round of consideration, the so-called trialogue negotiations. If the rules are enacted as they are, compliant crypto exchanges could be forced to halt transactions involving “unhosted” or self-custodied crypto wallets.

The tax reporting deadline is nearing across the Atlantic, and the Biden administration has revealed its plan to reduce the budget deficit by almost $5 billion by streamlining the reporting rules and collection of digital asset taxes in the upcoming fiscal year.

On the monetary policy front, the White House seems to have secured the passage of its four Federal Reserve nominees to the full Senate vote. Something that would be considered a formality back in the day, the Fed nomination process has become yet another partisan battlefield amid the increasing politicization of monetary policy.

Self-hosted doesn’t mean “unhosted”

The origins of regulators’ habit of framing a crypto wallet that is not custodied on a centralized platform as “unhosted” — a term that already conveys a certain air of neglect — can be traced back to at least December 2020, when the United States Treasury first attempted to impose financial monitoring requirements on crypto exchanges that facilitate transactions to such wallets. Using this language creates an impression that the only acceptable format of a “lawful” crypto wallet is being “hosted” by some centralized third party — an idea that is absurd for most people in the crypto space.

Armed with this rhetorical weapon and with the spirit of the Financial Action Task Force’s “Travel Rule,” the EU lawmakers went above and beyond what the international group’s guidance holds. While the FATF recommends that the reporting of transacting parties’ personal data be triggered by transactions between exchanges and personal wallets worth more than $1,000, the proposed EU rules extend this to any such transactions, regardless of their value. Additionally, users sending funds from a wallet to an exchange would be required to report to the platform the identity of the “unhosted” wallet’s beneficial owner, and exchanges would have to verify this information. Clearly, such requirements will put a heavy burden on compliant virtual asset service providers.

A digital dollar without surveillance?

Stephen Lynch, a member of the U.S. House of Representatives from Massachusetts, has introduced a legislative initiative proposing a form of digital cash that seeks to maximize consumer protection and data privacy. The proposal is apparently designed to address privacy and financial surveillance concerns around a potential U.S. central bank digital currency (CBDC) that several members of Congress have expressed in the past few months. For one, the prospective e-cash would not even formally qualify as a central bank currency, since the Treasury would be tasked with developing the pilot. At the same time, the bill explicitly states that the proposed Treasury money is not supposed to preclude or replace a prospective Federal Reserve-issued CBDC. Meanwhile, the movement to block the Fed’s ability to issue a retail-focused digital currency has gotten a second wind this week, with U.S. Senator Ted Cruz sponsoring a companion bill to Representative Tom Emmer’s earlier legislation aiming at just that.

All quiet on the BTC ETF front

Another spot Bitcoin exchange-traded fund application bites the dust: This week, the U.S. Securities and Exchange Commission has turned down the proposed rule change to allow ARK 21Shares Bitcoin ETF to trade on the Chicago Board Options Exchange. The justification cited the familiar mantra that the proposed product failed to meet the requirements of the Exchange Act in that it lacked “a comprehensive surveillance-sharing agreement with a regulated market of significant size” related to the underlying asset. Another contender for the distinction of sponsoring the first regulated spot Bitcoin ETF in the United States, Grayscale, is apparently preparing for a legal battle in case the regulator turns down its bid. The deadline for the SEC to render a decision on Grayscale’s product is July 7 of this year.