EU regulation – The End of Crypto Asset Custody?3 min read
This article is first on the Fin Law Blog published.
The European crypto industry had just averted the attack by the Greens, Social Democrats and Left parties on the PoW consensus mechanism with a narrow majority, and the next thriller is already looming. There was a proposed change in the EU Parliament for the forthcoming revision of the EU money transfer regulation, which, in addition to the obligation for crypto service providers in the Union to determine and verify the identity of the owner of the crypto wallets involved in all incoming and outgoing crypto transactions, also provides for the obligation to that crypto service providers may not allow transfers of crypto assets to wallets that do not allow these identification measures.
The proposed regulation aims to prevent anonymous transactions with crypto assets in the European Union in the regulated financial system. In particular, money launderers, terrorist financiers and other dishonest market participants should be deprived of the opportunity to move assets into crypto values and then transfer them to the regulated financial system. Since exchange platforms for crypto assets will be supervised institutions throughout Europe once the new Markets in Crypto Assets Regulation (MiCA) comes into force, if the proposal is implemented, users will only be able to convert crypto into fiat money via crypto exchange platforms if their identification data is disclosed in full.
The EU Parliament accepts the proposed amendment – trilogue negotiations are still pending
Last week, the EU Parliament voted on the new version of the EU money transfer regulation and voted in favor of the proposed amendment with a narrow majority. The entry into force of the new EU money transfer regulation has not yet been finally decided, because the draft still has to be negotiated and accepted in the so-called trilogue negotiations between the EU Parliament, the EU Commission and the Council of the European Union. If the regulation were adopted and passed in the current version, the European crypto industry fears that the use of crypto values in large parts of Europe would only be possible if the authorized and supervised crypto service providers were used.
They see themselves exposed to an enormous amount of administrative work because they always have to properly identify and check all those involved in the transaction. Especially for so-called unhosted wallets, i.e. crypto wallets that are not managed by an approved provider but are operated privately or decentrally, the new regulation would be a potential showstopper for linking the centralized financial system with the decentralized crypto market.
What would the new regulations mean for private unhosted wallets?
With regard to privately managed wallets, providers should still be able to identify the respective private individual and verify his or her identity even if the proposal is passed. The self-custody of crypto assets would therefore not necessarily be in danger. Still, of course, as a practical matter, it might be too much and costly for many providers to identify and verify every private wallet.
You may make a business decision not to offer unhosted wallet transactions at all. This could effectively force crypto users to use approved crypto custodians, which would mean taking on an additional third-party risk, especially given the “not your keys – not your coins” principle. As a result, the crypto market would again be centralized to a considerable extent by regulation. The technical innovation of blockchain technology of decentralized transactions without the mandatory involvement of service providers would fall by the wayside.