EU crackdown on non-custodial wallets
On March 31, the European Parliament’s Committee on Economic and Monetary Affairs (ECON) approved provisions to Europe’s Transfer of Funds Regulation that restrict Virtual Asset Service Providers (VASPs) from transacting with unhosted wallets without verifying their owners’ identities beforehand
Non-custodial wallets have exploded in popularity with the growth of DeFi - but the European Union looks set to change that.
"In the case of a transfer of crypto-assets from or to a crypto-asset wallet not held by a third party, known as an ‘unhosted wallet,’ the crypto-asset service provider or other obliged entity should obtain and retain the required originator and beneficiary information from their customer."
In other words, the regulation would compel crypto exchanges to verify the identity of every individual owner of a non-custodial wallet associated with the exchange. So anytime you transfer crypto from a centralized exchange to a non-custodial wallet, your exchange would need to collect and share data about this transaction.
In even worse news, the new guidance proposes that crypto exchanges must report any transaction greater than €1,000 to the relevant authorities.
The unexpected blow for the crypto market arrived in the form of European Union lawmakers who voted in favor of controversial measures to outlaw anonymous crypto transactions — a move that industry players believe would stifle innovation and invade privacy.
While the regulation is proposed currently and will continue to be negotiated - its effect was felt immediately on the market.
Unsurprisingly, the crypto industry has reacted negatively to the news. Coinbase CEO Brian Armstrong tweeted:
"This eviscerates all of the EU’s work to be a global leader in privacy law and policy. It also disproportionately punishes crypto holders and erodes their individual rights in deeply concerning ways. It's bad policy.”
Tony Dhanjal, Head of Tax at Koinly adds "Reading between the lines, there’s perhaps little doubt that this proposal harbors the intention of ensuring tax revenues are collected from transactions that potentially give rise to a taxable event involving non-custodial wallets - hitherto this regulation being enacted thrives on anonymity."
For individual investors utilizing non-custodial wallets, this could be a game changer if passed. Many wallets may refuse to comply with the new Know Your Customer (KYC) requirements from exchanges and choose instead to simply withdraw from EU operations.
For exchanges, it presents a monumental task of changing their KYC verification processes to comply with the regulations. As such, cryptocurrency exchanges without Know Your Customer (KYC) requirements may not remain operational in the EU in the long term.