FinCEN’s Proposed Crypto Wallet Rule Might Hit DeFi
A proposal by the U.S. Financial Crimes Enforcement Network (FinCEN) that crypto exchanges collect personal information, including names and home addresses, from people wishing to transfer cryptocurrencies into their own wallets is ill-defined and could have far-reaching implications, according to a number of regulatory experts.
The proposed rule, unveiled last Friday, would require a crypto exchange to collect this personal information from customers transferring a total of $ 3,000 per day to "non-hosted" wallets (which FinCEN also considers self-hosted or self-managed purses). Crypto users may know them as personal wallets or simply wallets. For transfers greater than $ 10,000 per day, the exchange would need to send a Currency Transaction Report (CTR) to FinCEN reporting those transactions and the people making them to the federal government.
The proposed rule-making, posted on the Federal Register on December 23, quickly sparked widespread backlash in the industry. Complaints ranged from the poorly defined terms of the document to the rash process. Comments are due by January 4th, reducing the usually month-long public comment period to just two weeks.
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The controversial rule is said to be a personal project of Treasury Secretary Steven Mnuchin, said Jeremy Allaire, CEO of USDC Stablecoin Co-Issuer Circle. It was originally thought to be far stricter than the final version released last week.
Additionally, the rule appears to be stalled during the regulatory process to ensure it is implemented before President-elect Joe Biden takes office next month, said Nick Neuman, CEO of bitcoin self-storage company Casa.
The reduced comment deadline reduces the time it takes to share exchanges to determine if they need to change their internal processes to ensure compliance, said Amy Davine Kim, chief policy officer of the Chamber of Digital Commerce Advocacy. How the exchange would come about is also open, she said.
"It could also cause these regulated financial institutions to disrupt transactions with self-hosted wallets as the impact of this rule is extremely brief while they implement the tools, processes, and procedures to implement the requirements," said Kim.
See also: "There is no emergency here": Coinbase asks FinCEN to extend the comment period for Wallet Regs
Several important details of the proposed rule-setting are poorly defined, several people told CoinDesk.
Perhaps the most noticeable omission: "Unhosted Wallets", FinCEN's preferred term for storing its own crypto, is not defined in the proposed rule, said both Kim and Seward & Kissel Associate Andrew Jacobson.
“In particular, the foreword of the NPRM [Notice of Proposed Rulemaking] explicitly refers to“ non-hosted wallets ”which call for the necessity of the proposed rule. However, the actual language of the proposed rule does not mention or define non-hosted wallets, so the rule in its explanatory language does not match the actual language of the rule, ”said Kim.
Jacobson agreed, telling CoinDesk that while there are "Explanatory Notes and Reasons" pages explaining the regulation and discussing non-hosted wallets, the proposed regulation does not specify exactly what non-hosted wallets are. A review of the document by CoinDesk confirms this.
Read More: US Floats Long-Dread Plan To Let Crypto Exchanges Identify Personal Wallets
The actual reporting requirements are also unclear, Allaire said. While names and addresses must be recorded and transmitted, the proposed rule creation does not specify whether IP or blockchain addresses are also required.
Nor does the proposed rule-making say whether financial institutions need to collect this information from counterparties or whether customers can simply submit this information, Kim said.
Finally, how would the rule handle the CTR aggregation requirements for customers using multiple wallets? The CTR requirement depends on the customer, not the wallet, ”she said.
The rule itself is unlikely to have any impact on end users, Neuman said. While there were initially rumors that Treasury's proposed rule-making would be far stricter - possibly even to ban unhosted wallets entirely - it would have been far more difficult to implement.
"What is not clear is how the regulated service providers like exchanges will actually implement this," he said. "Compliance will be required when the rule is between exchanges, brokers and other custodians. They need to implement this one way or another, and how they implement this is important to the user experience."
Exchanges may need to whitelist individual wallet addresses to ensure that no money is sent to a wallet without the required personal information.
One area that is likely to be affected is decentralized funding (DeFi). Several people told CoinDesk that the biggest - and least clear - impact of the proposed rule would be on DeFi projects.
For one, many DeFi projects rely on smart contracts to store or deposit funds. For example, users can engage with Compound by connecting their MetaMask wallet to the credit platform. Subsequent transactions are shown in the wallet itself and are unique to the user's holdings.
In addition, these intelligent contract-based platforms do not have physical addresses, nor do they necessarily operate under the auspices of an actual company. In short, Uniswap would stand if the founders of Uniswap were arrested.
It is unclear how such DeFi platforms would be treated under the rule proposed by FinCEN.
"Because smart contracts don't have a name or a physical address, they may not be able to interact with the US financial system," said Kim.
Read more: Coinbase CEO: Trump Administration Can "Pull Out" Annoying Crypto Wallet Rules
Plus, smart contracts don't necessarily have counterparties, Allaire said. When a company tries to send a large payment independently using crypto, it needs the names and addresses of the counterparties. Institutional investors who provide liquidity to a DeFi platform would probably not be affected by such rules.
This could bring an entire segment of the blockchain industry into a legal gray area, said Kim of the Digital Chamber.
"The Treasury Department should not impose a rule that could adversely affect this promising area of development without understanding the benefits to innovation," she said.
“What if you want to send to the compound protocol? There's no name or address, it's a market, ”said Allaire. "This could mean that DeFi protocols can only be used outside of the US."
This could even affect the Eth 2.0 deployment contract, he said. To take part in the next iteration of the Ethereum blockchain, users will need to send 32 ETH to the smart contract, or around $ 20,000 - well beyond FinCEN's limits.
"The vagueness of the rule also raises the question of whether funds used in DeFi would or could be accepted if a user tried to move those funds to a 'hosted' wallet," said Kim.
Allaire noted that the FinCEN rule raises new questions about privacy and how government regulators are handling privacy concerns related to digital money. If an exchange is required to provide blockchain addresses, physical addresses, and names to the agency, the federal government may be able to essentially track a person's digital activities.
This is different from treating physical money, he said.
"If you leave a bank, they can report that you did, but they cannot track you," he said. "There is a huge amount of personally identifiable information being blown up all over the world."
Additionally, the rule could prove counterproductive to FinCEN's actual mission to track down malicious actors, Jacobson said. While the new reporting requirements could drive bad players off the US exchanges, it is likely that they will just settle on an offshore platform.
"In some ways, that's not a bad thing, but it could affect FinCEN's regulatory goals as they don't collect [this data]," he noted.
Read more: Self-hosted Bitcoin wallets are at the forefront in the battle over crypto regulations
The number of questions raised by the proposed rulemaking should mean that the comment deadline should be extended and that the finance department be working with industry participants, Allaire said.
Kim noted that the customer due diligence rule for banks was taking more than four years to implement and saw advance notice of the proposed rule-making and extensive industry discussions.
Stakeholders and companies like Coinbase have already started creating comment letters responding to the rule proposed by FinCEN.
Coin Center even set up a module to streamline the process for the general public.
"If we don't take the right approach, the US could come under significant pressure in terms of development and innovation compared to other regions of the world," said Casa Neuman. "We definitely don't want that to happen, so it's up to us to make sure."
The Crypto Wallet rule proposed by FinCEN could hit DeFi
The Crypto Wallet rule proposed by FinCEN could hit DeFi
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