Custodial Wallets
Global regulatory authorities: FATF and FinCEN are becoming increasingly worried over the non-hosted crypto wallets. When it comes down to storing cryptocurrency, people have multiple choices. They can opt for hosted wallets, also known as a custodial wallet. It includes a host that usually takes, stores, and transmits the crypto assets on the customer’s behalf.
For instance, a centralized crypto exchange firm can act as a hosted wallet provider with which a client can set up an account. This way, the funds are handled by the wallet provider, but the value of the funds belongs to the holder of the account.
The hosted wallets provide the involvement of the financial institutions, however, there are wallets that do not involve third party involvement. Such wallets, known as non-hosted wallets, can cause financial crimes including money laundering terrorism funding. This is such a huge gap in the crypto industry, and it is starting to attract the attention of the financial watchdogs.
Procedures & Scams of Non-Hosted Wallets
Like the hosted wallets, cryptocurrency can be stored in the non-hosted as well. Non-hosted wallets are also known as self-hosted wallets which are based on software installed on a computer. The individual who owns the value also controls the funds in the wallet without requiring any service provider.
Want to learn more about Value investing and add another skillset to your trading arsenal? Check out the Book “The Intelligent Investor”. You can get your copy here.
This is very similar to fiat currency with physical cash in the physical wallet. The users of the non-hosted wallets can directly deal with other non-hosted wallets and can send or exchange their crypto assets. They can even exchange their platforms without having to identify themselves. Hence the transactions related to the non-hosted wallets can be linked to money laundering and terrorism factor. The anonymity factor and the lack of involvement of a third party make it hard to trace the trail of the funds and investigate for the financial crime.
The Financial Crimes Enforcement Network (FinCEN), is the USA’s authority to regulate the financial system and prevent financial crimes.
The data of the public on the blockchain is known to be more transparent and could be tracked; however it falls behind on recommendations of regulatory authorities like FinCEN for mitigating the threat of non-hosted wallets.
Financial Crimes Enforcement Network (FinCEN)
Recently, FinCEN issued “Requirements for Certain Transactions Involving Convertible Virtual Currency or Digital Assets”, a proposal with the mission to tackle the illicit financial threat brought by the non-hosted wallets. FinCEN raised the need to develop new reporting and recordkeeping requirements. These requirements are similar to the rules for traditional money.
These new requirements are applicable to the transactions and all other payment activities involving non-hosted wallets, they are also applicable to the virtual currency with legal tender through a bank.
It also includes a threshold for transactions. For instance, if a transaction is made of more than $10,000, the banks or the money service business must inform FinCEN and include certain information regarding the transaction. The financial institution must also provide proof of verification of the identity of the customer, including physical address to FinCEN. If the transaction is only more than $3,000, then the financial institution must record the transaction and customer information.
Financial Action Task Force (FATF)
A little after the FinCEN’s guidelines, the Financial Action Task Force (FATF), a global regulatory authority, issued guidelines for virtual assets and virtual asset service providers. FATF has pointed out that the transactions made to or from the non-hosted wallets are high-risk transactions by VASPs (Virtual Asset Service Providers) and should be treated accordingly.
FATF has also indicated the need for individual countries to know how P2P transactions are being utilized in their area and what is the risk for potential money laundering and terrorism financing raised through this. If the risk is high, the countries must work towards making an improvement in the visibility of P2P transactions.
FATF recommendations place AML/CFT requirements on the intermediaries between the individual and not on the individuals. In the case of the virtual asset providers, FATF recommends that the transfer of the virtual assets must be considered high-risk transactions.
Countries are recommended to ponder over additional limitations, controls or prohibitions targeting the non-hosted wallets, Virtual Asset Service Providers can choose to limit the transactions regarding the non-hosted wallets that are known to carry out P2P transactions
Other Regulatory Authorities
Financial watchdogs in the Netherlands and Switzerland have already implemented rigid controls. The regulations in the Netherlands also require: identity, customers and the service providers are screened against sanction lists to ensure that neither is not a potential threat.
The Financial Market Supervisory Authority in Switzerland has enforced a strict restriction on transactions over 1,000 Swiss francs including the non-hosted wallets. The regulations also require the identification of the customers and developing transparency for beneficial ownership.
Dutch National Bank (DNB), the central bank of the Netherlands, also laid out strict, the crypto service providers must also prove their compliance with the verification regulations under the 1997 Sanctions Act.
Interested in more articles about Crypto? Check out some of the recent publications from MoneyMidnight authors here
