ECON and the Future of Unhosted Wallets in Europe

Legislative FUD (Fear, Uncertainty, and Doubt) has been rife over the last 12 months. But, the latest worrisome news is that the European Parliament Committee on Economic and Monetary Affairs (ECON) has voted in favor of a proposal that could stifle crypto and decentralized finance (DeFi) as we know it.

On Thursday, March 31, 2022, the ECON voted in favor of a proposal that cracks down on unhosted Digital Asset wallets. an Unhosted Wallet means a software or hardware wallet that allows one to hold, store, and transfer crypto-assets and is not hosted by a third party, such as a financial institution or a credit service provider.

In brief, the proposal includes a revision of the Transfer of Funds Regulation (TFR) that will extend the obligation of financial institutions to add KYC (Know Your Customer) to transfers of funds with personal information of the parties involved.

The most concerning parts of the proposal:

1. Crypto service providers will now have to collect and verify the personal data of all involved parties of crypto transfers when an unhosted wallet is involved. Interestingly, no information has been provided as to how this will be achieved…

Worst case, this could lead many service providers to cease offering transfer to and from unhosted wallets until clarification is forthcoming. Smaller exchanges may choose an outright ban based on the logistical costs of adhering to this regulation.

This also implies that no one is safe. For example, if someone in Africa is looking to send Digital Assets from their MetaMask or Trustwallet to someone in Europe’s Coinbase wallet, they too will need to have their data recorded, even though they are not actually a Coinbase customer or even in Europe. In effect, everyone becomes a customer and will need to fill out a KYC form.

It strikes me that users will be more likely to leave their Digital Assets on third-party exchanges to avoid this problem. What that means for the security of Digital Assets: “not your keys, not your coins!!”

2. Any transfer over 1,000 euros will have to be reported to the Anti-Money Laundering (AML) authorities. This will apply to all transactions, regardless of whether it looks suspicious or not. This proposal constitutes a major violation of personal privacy. As Coinbase CEO, Brian Armstrong, said “Imagine if the EU required your bank to report you to the authorities every time you paid your rent merely because the transaction was over 1,000 euros.” Seems like massive overreach to me.

3. One year after the proposal is passed, the EU commission will reassess to find “additional specific measures to mitigate the risks posed by transfers from or to unhosted wallets, including the introduction of possible restrictions.”

So, what does that mean? A complete ban on any kind of transfer involving an unhosted wallet, as was already suggested by some members of the parliament in an earlier draft?

What about all the data that will be harvested through this proposed legislation? Fundamentally, you are not safe anymore. The data will have to be collated and stored by crypto exchanges and stored on a centralized server that could be susceptible to a data breach. Imagine hackers knowing that you own a Ledger Nano containing 10 bitcoin. The risk of an attack can’t be discounted.

The proposed legislation dramatically undermines some of the core workings and fundamental values of the DeFi space. While the application of the ruling is purely focused on Europe, it does indeed have further, far-reaching ramifications if one party is outside of the EU.

If this regulation is to be implemented in full — or worse still — with even more draconian measures included at a later stage, then developer activity could be severely stifled with them unlikely to build protocols that could be subject to an EU ban. I doubt that VC money would be too interested to continue funding projects that could be affected by these proposed laws.

Having said all this, we still have time. The proposal is not due to be implemented until 2024 so a strong campaign could divert it. This also strikes me as being very unfair. Will the new ruling apply to TradFi too? Finally, to give us hope, there’s one of my favourite personal sayings about this space: “Since when did technology ever lose?!” The blockchain and Digital Asset space have an amazing way of sidestepping, reinventing, and developing their way out of overbearing regulatory situations. I’m guessing we’ll be OK.