The Breakdown - The Battle for Self-Hosted Wallets

Episode Date: June 28, 2022

This episode is sponsored by Nexo.io, NEAR and FTX US.    On today’s episode, NLW explores the ongoing policy debate around “unhosted” (or, as crypto users call them – “self-hosted”) wallets, looking at MiCA legislation in Europe, an updated policy for the U.K. and hints from the Biden administration in the U.S.  - Nexo is an all-in-one platform where you can buy crypto with a bank card and earn up to 16% interest on your assets. On the platform you can also swap 300+ market pairs and borrow against your crypto from 0% APR. Sign up at nexo.io by June 30 and receive up to $150 in BTC. - NEAR is a blockchain for a world reimagined. Through simple, secure, and scalable technology, NEAR empowers millions to invent and explore new experiences. Business, creativity, and community are being reimagined for a more sustainable and inclusive future. Find out more at NEAR.org. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsors is “Catnip” by Famous Cats and “I Don't Know How To Explain It” by Aaron Sprinkle. Image credit: Westend61/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

We've seen over and over that the first attempts from regulators tend to be to draw those threshold at lower levels than traditional money and financial assets, in many cases because of a perception of crypto being for criminals. A second layer of the fight, though, will be the principle of the thing. And make no mistake, this will be a legal battle. It'll be a battle of how different attempts at financial surveillance run a foul of protections enshrined in governing principles such as the Constitution. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world.

The breakdown is sponsored by nexo.io, near NFTX, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, June 27th, and today we are talking about the battle for self-hosted wallets. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dig deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.le slash breakdown pod. Also, a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. So, I am traveling for the next few days and so I've prepped the set of shows in advance. Today we are talking about one of the most important lingering things that lurks around every regulatory

corner and absolutely cuts to the quick of what it means to be involved in crypto. That's the battle for self-hosted wallets, or as politicians seem to call them, unhosted wallets. In the midst of the Celsius meltdown, David Bailey, the CEO of Bitcoin magazine tweeted, okay, so if this gets as bad as it could get, the bright side is that attempts to ban self-custody and self-hosted wallets will be dead in the water going forward. Self-custody is the point. What David was arguing is that the implosion of an opaque third party that theoretically held people's assets in trust, but was actually out betting them on risky opportunities to generate yield, could do much to impress the need for the enshrinement of the default option to self-custody

digital assets. Basically, without the option to self-custody, people would have to roll the dice and choose a custodian. The idea of limiting the potential consumer security benefits based on improvement of technology seems insane to so many of us, but, is a central idea for a lot of the political establishment. So let's discuss the fundamentals. On the one hand, you have a key principle of Bitcoin, which is not your keys, not your coins. That monetary sovereignty became part of crypto in general, and in this space it is totally non-contentious that sovereign individuals should have the choice to custody their assets without relying on intermediaries and third parties. This is not just a matter of efficiency and cost, although there's that dimension as well.

It's more of fundamental articulation of principle or even rights. On the other side of the debate, however, is the KYC-AML establishment. This is the group who view crypto's main purpose as creating a monetary alternative outside of the surveillance of the traditional financial system. For so many of these folks, self-hosted wallets represent not just an off-ramp from banks, but an on-ramp to potential criminality. Now, in practice, this is going to be a fight that happens on two dimensions simultaneously. One will be in the details. A huge amount of mainstream, quote-unquote, crypto usage, including with

Bitcoin, will be subject to transactional surveillance at some threshold or another. A lot of the battles we will have will be about where to draw those thresholds. We've seen over and over that the first attempts from regulators tend to be to draw those thresholds at lower levels than traditional money and financial assets, in many cases because of a perception of crypto being for criminals. A second layer of the fight, though, will be the principle of the thing. And make no mistake, this will be a legal battle. It'll be a battle of how different attempts at financial surveillance run afoul of protections enshrined in governing principles such as the Constitution. So what then is the state of this battle? Well, let's look at Europe first.

A few times over the past couple of months, we've looked at the push in Europe for the markets in crypto assets or Mika framework. Specifically, I've discussed how many of the provisions of the bill have been pushed through in weird, aggressive late-night sessions, etc. Anyway, early last week, ECB President Christine Lagarde, spoke about MECA in front of the EU Parliament. Patrick Hansen, who has become the go-to summarizer of all things Europe crypto regulation had the highlights. Quote, crypto assets in DFI have the potential to pose real risks to financial stability. She also called for a Mika 2.0 regulation that covers staking and lending, defy, and assets without an identifiable issuer.

Ligard again, Mika 1.0 will not be implemented until 2024, which is the long way away when you think of the speed of which market values and creativity and greed actually impact those developments. Mika 2.0 would have a larger scope and would regulate in-depth some of those innovations in these uncharted territories that put consumers at risk and where the lack of regulation is covering fraud, completely illegitimate claims about valuations, speculation, and criminal dealings. The ESRB, European Systemic Risk Board, will raise the alarm bell when it sees that there is an interconnection risk that would call for action. Hansen summarizes, as Mika is not even finalized yet, this comment is quite surprising and probably driven by current market events.

Now, why this matters is that the most controversial provision in the Mika framework is a crackdown on exactly the type of self-hosted wallets we're discussing. The current provisions being debated would require all self-hosted wallets to have a verified identity provided to the regulator, and all transfers of more than $1,000 to be reported in the same way that suspicious transactions are in the regular financial system. On April 1st, a small minority in the EU parliament voted for traceability regulations that would effectively end anonymous crypto flows in the EU. This is a broadening of anti-money laundering laws. As one company put it, under the new measures, rules that apply to payments and transfers over €1,000 would be applied to crypto,

except without any threshold, meaning that even the smallest movements of crypto funds would be forced to use KYC. This also includes self-hosted or unhosted wallet. Originally, the plan had been to limit the new measures to crypto transactions over 1,000 euro, as is the case of the traditional financial market. But the legislator said an exemption for smaller transfers would make it too easy for criminals to evade the rule with lots of tiny payments. Nexo lets you easily buy crypto with your bank card and earn industry-leading interest rates. Earn up to 16% on crypto and up to 12% on stable coins.

Nexo makes passive income easy, with interest paid automatically and daily. With Nexo, you can also borrow against your crypto at 0% APR and exchange over 300 pairs. Receive a welcome bonus of up to $150 in Bitcoin until June 30th at nexo.io. That's nexo.io. This episode is brought to you by Meir, a climate neutral, high speed, and low transaction fee, layer one blockchain platform. MIR is a blockchain for a world reimagined. Through simple, secure, and scalable technology, NIR empowers millions to invent and explore new experiences. Business, creativity, and community are being reimagined for a more sustainable and inclusive future.

Reimagined your world today at NIR.org. The breakdown is sponsored by FTXUS. FTXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no. No-ACH transaction fees and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs.

When you trade NFTs on FTCS, you pay no gas fees. Download the FTCX app today and use referral code breakdown to support the show. Coinbase's Brian Armstrong summed up many of the industry's feelings on this, writing, The latest draft by Parliament of the Transfer of Funds Regulation treats crypto and every person who holds crypto differently from Fiat. Every crypto transaction would be travel rule eligible. This means before you can send a receive crypto from a self-hosted wallet, Coinbase will be required to collect, store, and verify information on the other party,

which is not our customer, before the transfer is allowed. Moreover, anytime you receive €1,000 or more in crypto from a self-hosted wallet, Coinbase would be required to report you to the authorities. This applies even if there is no indication of suspicious activity. 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. Or if you sent money to your cousin to help with groceries, the EU required your bank to collect and verify private information about your cousin before allowing you to send the funds. How could the bank even comply? The banks would push back,

and that's what we're doing now. 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. Currently, the regulations are in a parliamentary consultation process known as the trilogues, which are expected to conclude in July. Now, last week, we also got interesting news out of the UK on this same question. In July 21, the UK Treasury proposed an amendment to money laundering legislation that would have required crypto businesses to report all transactions involving self-hosted wallets. The consultation period for that amendment ended in October, and the report has now been

published. The money line is, instead of requiring the collection of beneficiary and originator information for all unhosted wallet transfers, crypto asset businesses will only be expected to collect this information for transactions identified as posing an elevated risk of illicit finance. In other words, this means that only suspicious transactions will be recorded. This is a similar threshold that appears in most banking compliance legislation. What's more, the report found that there was, quote, no evidence of disproportionate risk in the use of self-hosted wallets. quote, the government does not agree that unhosted wallet transactions should automatically be viewed as higher risk. Many persons who hold crypto assets for legitimate purposes use unhosted wallets

due to their customizability and potential security advantages, e.g. cold wallet storage. And there is not good evidence that unhosted wallets present a disproportionate risk of being used in illicit finance. Some of the main responses among industry stakeholders during the consultation period were citing concerns about the cost of compliance, that the amount of data collection was disproportionate to the risks presented, and that the nature of open-ledger blockchains in combination with the collection of private data caused the risk of significant privacy violations. Alex Davis, legal counsel at ChainSafe, said huge kudos to the UK for backtracking on rules requiring rage K-Y-seeing all transactions with self-hosted wallets.

It seems to me that this is in line with the UK's recent pivot to intending to be a crypto hub. But what about in the U.S.? This has been an ongoing battle. One of the 11th hour FUs from the Trump administration was a proposal by Stephen Mnuchin, then Treasury Secretary, to enforce identity checks on private wallets. This has been postponed over and over by the Biden administration, but hasn't gone away. Indeed, in January of this year, the Treasury Department revealed that it might consider

this rule this year. Now, a lot has happened in the U.S. regulatory environment since then, but it's still clearly not off the table. From the recent consensus conference, Wally Adie Amo, the Deputy Secretary of the Treasury, said that storing crypto anonymously outside of regulated venues was a way for people to bypass sanctions in AML checks. Quote, we're working to address the unique risks associated with unhosted wallets. Unhosted wallets are effectively just addresses on a blockchain. It can be difficult to determine who really owns and controls them, creating opportunities to abuse this heightened anonymity.

Now note again the use of unhosted here. It is such a telling phrase. Unhosted conveys that it isn't hosted by anyone. It suggests that the individual, isn't an appropriate host for their own money and assets. It is a deeply problematic linguistic construction and a tool of the propaganda fight. Adayama went on, I understand and respect the need for and the desire for privacy. But we need to make sure that we're also in a place where we're not creating avenues where those who want to move funds illicitly

are able to use digital assets more than traditional assets. Not to put too fine a point on it, but, quote, I respect the need for and desire for privacy, but means that you care neither about the need nor desire for privacy. privacy. The theoretical bright spot, I guess, in his statement is, the only way we can stop illicit actors from operating is in partnership with investors and with innovators. And he vowed to ensure that, quote, responsible actors in the space are the partners of government rather than working in opposition to us or feeling as if our rules

don't give you the room to innovate in a way that helps us solve these problems. This is not a question about innovation, to be clear. This is a question about the same sort of transactional privacy that people have right now using cash. Big, shifty, side eye from me on this one, Wally. Marty Bent recently wrote, Fadoff plans on releasing a report with a, quote, brief update on the risks associated with unhosted wallets at the end of the month.

The narrative battle is about to heat up. Let's be clear. Private key ownership is a non-starter. Don't seed an inch. I really do think that this is an issue that needs our focus. Matt Corallo writes, while everyone was distracted with the New York State behind the meter fossil fuel mining ban, policymakers are still talking about attempting to apply travel rule to unhosted wallets. This is by far the most important fight in the ability to use

Bitcoin regulatory front. If these policies move forward, the impact is likely to include having to ask people you send or receive money from and two for their full legal name and physical address, a massive invasion of privacy substantially beyond anything in the regular banking world. I'm not sure why anyone would choose to use Bitcoin in such a world. If you have to dox yourself to someone you sent or received $20 to or from, why on earth would you do that? Again, this is by far the most important regulatory fight today, and one we're not focused on enough. This episode is my attempt to hopefully bring you up to speed a little bit more on this issue. There are positive places that we can land on this. Regulators don't have to be the enemy,

but there does have to be a baseline agreement about certain fundamental principles, and I'm not sure right now that we're there. Hopefully there's still time to actually have these conversations. For now, I want to say thanks again to my sponsors, nexo.io, near and FTX. and thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.