#237—Regulated self-custody wallets

Also, learnings from FTX

Dec 19, 2022

Welcome to Yaka Stuff, our weekly newsletter that covers news, industry perspectives, and updates from the Hard Yaka ecosystem. Check out last week’s report here.

This week:

Regulated self-custody wallets
Privacy and compliance aren’t mutually exclusive
New York’s crypto guidance for banks
Learnings from FTX
Stuff happens

1. Regulated self-custody wallets

Everyone expected increasing scrutiny in cryptoland, and it appears that Elizabeth Warren is first up to bat.

Her take, along with Senator Roger Marshall (R-KS), comes in the form of The Digital Asset Anti-Money Laundering Act of 2022 (via Chris).

Part of it is about extending Bank Secrecy Act (BSA) obligations such as KYC to more crypto related entities such as wallet providers, miners, ATMs and foreign banks (when Americans are transacting in digital assets)—along with strengthening enforcement.

Notably, they’re also targeting self-custody wallets. The bill would:

Address a major gap with respect to “unhosted” digital wallets – which allow individuals to bypass AML and sanctions checks – by directing FinCEN to finalize and implement its December 2020 proposed rule, which would require banks and MSBs to verify customer and counterparty identities, keep records, and file reports in relation to certain digital asset transactions involving unhosted wallets or wallets hosted in non-BSA compliant jurisdictions.

Axios, which believes the lame duck legislation “will probably fade out” is also calling it the “end of privacy”:

Americans would have no refuge in blockchains for financial privacy under legislation introduced by two U.S. senators, Brady writes.
Why it matters: A major driver for the creation of cryptocurrency was to give people a cash-like experience on the internet, with a digital currency that could be passed from one user to another, just like paper bills and coins.

Like cash, privacy isn't perfect with most cryptocurrencies, but both are more private than transactions with debit or credit cards that are tied to an identity.

…
Zoom out: At issue is the fact that cryptocurrency was designed to be a bearer asset, insofar as a person's identity wouldn't be tied to the digital assets they held.

In other words, a person could store it themselves, using software that people usually describe as a "wallet." The legislation refers to these as "unhosted" wallets.

The bill would require anyone facilitating transactions on a blockchain — such as the validators or miners that process them — to register as a financial institution and make certain guarantees about people using the network for higher-value transactions.

The other side: "The legislation is clear on its face," research director Peter Van Valkenburgh wrote for Coin Center, a non-profit focused on crypto policy issues. "The intended result is to forbid Americans from having any technological guarantees of personal privacy."

In October, Coin Center sued the U.S. Treasury after it sanctioned Tornado Cash, a privacy tool that runs on Ethereum.

Quick take: This is such far-reaching legislation that it's hard to imagine how existing blockchains would continue to operate in the United States.

It would be "simple," however, for new chains to launch designed to comply. Participation in running such a chain would be much more expensive, however, so it's unlikely to be as decentralized as Bitcoin or Ethereum.

One quick thing: Privacy and compliance don’t have to be mutually exclusive.

And while the bill may not get very far, in part, due to how far it reaches, it certainly gives a sense of how policymakers are thinking in terms of regulating the industry.

As Axios points out, there are spiritual similarities to a Trump-era rule that also required KYC for self-custody wallets.

Relevant:

2. Privacy and compliance aren’t mutually exclusive

Here’s The Block:

Deploying zero-knowledge proof cryptography could allow for "trustless privacy" in a central bank digital currency (CBDC), according to new research, addressing a major area of concern for a state-backed crypto projects.
The report by Mina Foundation, a decentralized network, and Etonec, a crypto payments group, looks to show that CBDCs can provide the same privacy levels as cash while also being compliant to anti-money laundering regulations.
“Providing anonymity for payments, while ensuring regulatory compliance, is not a technological question, but a policy question,” Jonas Gross, head of digital assets and currencies at Etonec and chairman of the Digital Euro Association, said in a statement to The Block.

Relevant:

3. New York’s crypto guidance for banks

Next up is the New York Department of Financial Services. Here’s the WSJ:

New York’s financial regulator said banks looking to enter the cryptocurrency space need to first seek approval from the regulator.
The New York Department of Financial Services, in a guidance document published Thursday, said it would assess new crypto-related activities proposed by financial institutions based on potential risks they may pose to the banks and consumers, and detailed the process for those entities hoping to get approval to offer crypto products and services.
U.S. banks and foreign banks with branches in New York that are under NYDFS supervision should notify the agency at least 90 days before starting any new or significantly different crypto-related activities, according to the guidance.
Additionally, banks are required to submit information across six categories: present their business plan, explain how they will manage crypto-related enterprisewide risk, provide details on how they will set up their corporate governance structure, how consumers will be protected, as well as spell out their financials and provide legal and regulatory analysis. The guidance also includes a supplemental checklist of documents the banks need to provide.
NYDFS is one of the first state financial regulators to issue such guidance for banks. “DFS’s regulations and guidance together form a supervisory framework that helps to protect consumers and preserve the safety and soundness of companies,” a spokeswoman for the agency said in an email.

Relevant:

New York Financial Regulator Issues Crypto Guidance for Banks

4. Learnings from FTX

Here’s Greg Kidd:

FTX shows the failure of regulations by (selective) enforcement—the SEC approach. The SEC becomes the wild card by picking winners and losers via who they choose (and chose not) to shake down.
It appears that Alameda May have been the instigator behind the attack on Terra Luna. And that CZ May have “returned the favor” on FTT.
What happens if Binance is next?

Relevant:

5. Ecosystem updates

Origin Trail is building a decentralized knowledge graph to support the global economy in industries such as supply chains, trade, and transportation. Last week, they launched V6. The livestream:

Yaka Stuff

#237—Regulated self-custody wallets

Also, learnings from FTX

1. Regulated self-custody wallets

2. Privacy and compliance aren’t mutually exclusive

3. New York’s crypto guidance for banks

4. Learnings from FTX

5. Ecosystem updates

6. Stuff happens

Discussion about this post