The Breakdown - The European Union vs. Self-Hosted Crypto Wallets

Starting point is 00:00:04 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 nexus.io, Arculus, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, March 31st, and today we are talking about self-hosted wallets and why they're coming under fire in the European Union. First, however, if you are enjoying the breakdown, please go subscribe, give it five stars where you can rate it, leave a review, or if you want to dig deeper into the conversation around crypto, macro, regulations, really anything that matters in this world of big picture power shifts, come join us on the Breakers Discord.

Starting point is 00:00:53 You can find a link in the show notes or go to bit.com. That's bit.ly. That's bit.ly.L.Y slash breakdown pod. Also a disclosure as always, in addition to them being a sponsor of the show, I also work with FTX. So we are here again, back just a couple of weeks after our last EU crypto show, and I'm going to try to unpack what's going on as dispassionately as possible. There are a lot of heated emotions right now for good reason, so let's try to understand what's actually been happening. As we discussed before, the Markets in Crypto Assets Directive, or Mika, been in the work since 2019, but it's recently had more momentum and more focus. For the last couple of months, the crypto industry's attention was on an anti-proof-of-work provision in the bill.

Starting point is 00:01:39 In February, there was a bit of a back-and-forth where first this anti-POWW provision was removed, and then just before an important last-minute vote in the Econ Committee of the EU Parliament, a version was added back, which said, quote, crypto assets shall be subject to minimum environmental sustainability standards with respect to their consensus mechanism used for validating transactions, before being issued, offered, or admitted to trading in the union. Crypto assets that are issued, offered, or admitted to trading in the union shall set up and maintain a phased rollout plan to ensure compliance with such requirements. So effectively, this would have been a ban on Bitcoin, Ethereum, and other proof-of-work chains.

Starting point is 00:02:16 Not on mining, mind you, but on trading. Exchanges wouldn't have been able to list these assets. At the time of that debate, Pierre Person, who's a French politician who is not in the EU Parliament, summed up the feelings of many saying, Mika regulation will be voted on next Monday. As it stands, it definitively condemns the future of crypto assets in Europe. By banning Bitcoin and ether, by complicating the use of NFTs and defy, the European Parliament is mortgaging our monetary and financial sovereignty. Once again, we are going against history.

Starting point is 00:02:44 Once again, we are leaving opportunities to others while boasting of having good regulation. If this text passes as it stands, we will pay the price in terms of our competitiveness and the interests of European citizens. Now, this took a lot of people, myself included off guard, but in fact, folks who pay attention to regulations in the U.S., like Jake Trevinsky, the head of Policy at the Blockchain Association, had in fact warned late last year that the industry as a whole might not have been focused enough on Europe. On December 1st, he tweeted, I fear we've been underestimating the potential impact of MECA on the crypto industry globally.

Starting point is 00:03:17 In the U.S., it feels like we've buried our heads in the sand, thinking it isn't our problem, and hoping it doesn't affect us. If GDPR is any example, that may be a big miscalculation. So let's zoom forward to today. What's going on? The European Parliament was hosting an important vote on new AML legislation with a focus on targeting crypto. Specifically, two committees voted today on amendments that are focused on unhosted wallets,

Starting point is 00:03:41 or, as we call them in this industry, self-hosted wallets, and yes, the distinction between those names is a political one that matters quite a bit. And the idea of this AML legislation would be that it could blow. lock EU-based exchanges and crypto service providers from interacting with those wallet owners that weren't identity verified. The rule would require that the, quote, provider of crypto asset transfers report the identity of the owner of unhosted wallets to the exchanges that they're transferring funds from, and exchanges would be required not just to collect that information, but to verify it. Nexo is the go-to platform for all things crypto. Invest in the hottest coins out there

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Starting point is 00:05:57 So to wrap our heads around a little bit of what this means, we turn once again to Patrick or Patty Hansen. He's the head of strategy and biz-dev at Unstoppable Defi, and has become the interlocutor of European Union politics for the crypto industry during these proceedings. He wrote last week, I hate to ring the alarm bell again, but the EU parliament leaves us no choice. First red flag, different from the initial proposal that only required to collect, not verify personal data from transfers made from slash to an unhosted wallet,

Starting point is 00:06:26 the draft now requires to, quote, verify the accuracy of information with respect to the originator or beneficiary behind the unhosted wallet. But it doesn't say exactly how a crypto service provider should be able to verify the unhosted counterparty. The consequence of this, in my opinion, is that most crypto companies won't be able or willing to transact with unhosted wallets anymore in order to stay compliant. Second, for every crypto transfer from an unhosted wallet over 1k euro, companies are obliged to inform the, quote, competent AML authorities. For all these transactions, even if there is no sign or suspicion of money laundering. This is an absolute violation of private rights. Third red flag, one year after entry into application, the EU Commission will assess

Starting point is 00:07:06 the need of, quote, additional specific measures to mitigate the risks posed by transfers from or two unhosted wallets, including the introduction of possible restrictions. This means that the EU Commission might be prohibiting transfers from and two unhosted wallets entirely, as was already suggested by some members of the Parliament in an earlier draft. Fourth, while the Financial Action Task Force travel rule only requires these measures for transactions over a certain amount, 1KUSD, and the TFR for Fiat only requires the information sharing for transfers over 1K euro, the draft sets no minimum thresholds for crypto transfers. That means that soon every single Satoshi transaction that is not purely P2P will have to be accompanied by the sharing of personal

Starting point is 00:07:46 information. This is a totally unjustifiable double standard. If anything, the AML requirements for cryptocurrency should be lower, since blockchain-based transfers offer new and additional ways to track and monitor. There are more problematic passages in the text, but these are the main ones to focus on. This proposal cracks down on unhosted wallets and creates huge data honeypots for hackers. What's concerning is that this time, different from the proof of work ban and the Mika regulation, the council or member states seem to be on the same page with the EU Parliament on these issues. No threshold for crypto transfers and crack down on unhosted wallets. Now, to this thread, Paul Tang, who's a member of the Progressive Alliance of Socialists and Democrats for the Netherlands,

Starting point is 00:08:24 responded, and Tang has made himself the chief provocateur on Twitter as it comes to this legislation. He writes, Another week, another social media storm by Crypto Bros. Now about the transfer of funds regulation. Just like bank transfers, transferring crypto like Bitcoin should be accompanied with information about the person sending and receiving the funds. Now the European Parliament wants to cover also transfers to and from unhosted wallets. These are wallets where crypto assets are stored on your PC without the involvement or knowledge of anyone else, similar to holding cash in your pocket. But cryptos are extremely mobile and operate in a borderless world. This means that funds from unhosted wallets often

Starting point is 00:08:58 come from unknown sources. And money going to unhosted wallets may end up in the wrong place, for example, with terrorist groups. So the identity of unhosted wallet holders needs identification, just like you need to identify yourself when you deposit money at the bank. And we want authorities to be notified in case any one person receives a total of 1,000 euro plus from unhosted wallets. This is a red flag. The parliament also covers all crypto transfers regardless of their monetary value. The unstable value of crypto assets makes a threshold in euros difficult to enforce, and smurfing allows for many small transfers to be coordinated so as to escape any threshold. These are important tools to fight money laundering and terrorist financing.

Starting point is 00:09:34 Some crypto lobbyists won't like the extra work, but being part of our society comes with obligations. Banks already fight criminal money. Cryptobros should step up to the plate and do so too. And so here in a single tweet and a quote tweet response, you have the gist of this argument. The great debate is about financial freedom and sovereignty on the one hand, versus the boogeyman of crime and societal obligations on the other. On the side of the state are MPs like Tang and Aurora Le Luc, who said, we are talking here about a serious subject,

Starting point is 00:10:03 the fight against money laundering, the financing of terrorism, crime, pedo crime, a subject that deserves no controversy, no buzz, avoiding new victims, defending the general interest. These are our values. On the other side are those who view these rules as overly strict, more strict in fact than the banks. Moritz-Corner from the Liberal Free Democratic Party representing Germany says, if we impose stricter rules on the crypto economy than on the traditional financial sector,

Starting point is 00:10:26 we risk once again over-regulating an innovative economic sector that will, as a result, thrive in markets outside the EU. Michael Huguen, a member of the European Conservatives and Reformists for the Netherlands, says, the greatest asset of blockchains are traceability and transparency. The amendments to the transfer of funds regulation make transfers to a wallet unnecessarily complicated, come with privacy risk and will hinder innovation. I will vote against it. Peer person, again, though not in the EU Parliament, also articulate,

Starting point is 00:10:52 a position of many. Regulating the uses of crypto requires a good understanding of how it works. We cannot transpose banking and financial regulation applied to a centralized ecosystem to a brand-new ecosystem. We have to invent a whole new KYC-AML model adapted to this new technology. This leads us to the determination of political objectives by the regulator. To date, the FATIF has not been able to adapt its recommendations to the new technological dimension. It needs to use tools enabled by this technology to work on a new framework based on the risk approach. To date, the presumption of guilt weighs on the centralized actors and users. The prohibitive approach seems to dominate in Europe. These choices will condemn these nations in financial competition.

Starting point is 00:11:29 The nations that have the courage to work, to learn without dogma, will be the winning nation in this international competition, not because they will be the lowest bidder, but because they will have known how to regulate intelligently. So there are obviously a lot of specifics to this debate. Wallet Company Ledger wrote a blog post, for example, pointing out using figures from chain analysis, compared to figures from the UN, that fiat currency money laundering is 232 times as large as crypto money laundering. Another starker way to put it is that the amount of money the UN estimates was laundered last year through traditional means is around the same size as the total crypto market cap. These are the types of details that should be debated with more time.

Starting point is 00:12:06 But I don't think those specifics are really why this issue gets so hot. I think why these debates are so triggering is that they are a microcosm of the great and central conceit of really all modern politics. the rights of individuals versus the obligations of participation in a society. I point that out as a way of saying that it is not only fair but good to have those debates, especially when they are had in good faith. This is a precarious balance that is constantly shifting. New threats and new circumstances do require new evaluations, but so too do threats to individual sovereignty.

Starting point is 00:12:37 If we really decide as a society that we have zero tolerance for any financial crime, then yes, we can also put human financial surveillance to 100 and financial sovereignty to zero, but that would also necessarily mean the end to cash, among other things. What it seems strange as an admittedly outside observer is the way in which two major issues now of dramatic importance to the cryptocurrency industry have been pushed into legislation at the last minute without a lot of time for the industry to comment and engage.

Starting point is 00:13:05 Now I will admit I could have the wrong of that. It could be partially on the industry that we haven't been paying enough attention or engaging enough. But it still feels strange and hurried. This sentiment was sort of validated by Silki Noah, a lawyer at Nosis who pointed to Russia's invasion of the Ukraine as an accelerating force for, well, everything. She writes, Since 2021, negotiations have been ongoing to extend the scope of the TFR to crypto, i.e. virtual asset service providers must collect and make accessible info about the sender and beneficiary

Starting point is 00:13:34 of crypto transfers. Due to the Russian invasion of Ukraine, the drafting of amendments has been speeded such that it now represents a master class in how to kill the EU's most promising industry. Whatever the case, unlike the Mika proof of work ban, this one did not go our way. At 10.21 a.m. this morning, East Coast time, Patty Hansen writes, Breaking the Econ and Lib committees of the EU Parliament voted in favor of the FTR compromises D&E that cracked down on quote-unquote unhosted wallets. The entire regulation draft to be voted on later today, but we'll certainly go through. So what happens from here? Well, one, I will not pretend to understand the EU legislative process at all.

Starting point is 00:14:13 But again, here's what Patrick Hansen had to say about it. After the vote today, the Econ proposal will be announced in the plenary session probably sometime in April. If no one challenges that by requesting a plenary vote, the trilogue between the EU Parliament Commission and Council will start shortly after. The trilogue usually takes a couple of months and offers the last chance to introduce changes. Individual voices from the Council and Commission make me optimistic that we can still achieve changes.

Starting point is 00:14:38 But the situation is undoubtedly more difficult than with the proof-of-work ban. Now, what about partisanship? Obviously, I talk about that a lot in the U.S., monitoring if and how crypto is becoming more or less partisan, and I've described how I believe that it is to crypto's benefit how it seems to be bucking the tide of rampant partisanship. In the EU, it would be tempting to look at these results and see it as a left alliance for this identity verification and a right alliance against it. But even here, that's not fully true. If Akali is the vice president of the Euro parliament and is from the Progressive Alliance of Socialists and Democrats and a member for Greece. She wrote on March 29th,

Starting point is 00:15:15 ahead of the vote for AML, it seems necessary to not put EU in the backseat of defy and innovation, but to support the initial approach of TFR. Proportionality and smart regulation for innovation-friendly principle should be the spirit. Hopefully EU will make the right decision. Eva kept up her tweeting this morning. She retweeted Cameron Winklevoss from Gemini, who said, when it comes to AML efforts, the inherent attributes of the blockchain, traceability, auditability, and transparency, allow it to be an effective tool to combat illegitimate activity, subject to protecting privacy and other individual rights. She also added transfer of funds from unhosted wallets to EU crypto asset service providers should be possible in a proportionate way. Otherwise,

Starting point is 00:15:55 EU risks circumvention of EU infrastructure via non-EU providers to fight crime and corruption while remaining tech-neutral and innovation-friendly. And finally, no matter what happens today, there is a need to discuss further in the European Parliament. We will host workshops with experts, and work with colleagues that have the best intentions for a proportionate responsibility of European Union crypto asset service providers. So there will be a lot more ink spilled on this. There will be debates in the EU around the specifics of wallets,

Starting point is 00:16:23 around the practicality and legality of requiring parties to provide KYC of third parties, of crypto's relevance to the EU economy and more. There will be a temptation by many in the crypto industry to say, screw them all, to believe firmly that this means that the regulators in the European Union do not have the best interest of this industry anywhere near their priorities.

Starting point is 00:16:42 But I think that it would be a mistake. It may be late in the game, but the process isn't over. And what's more, even if it's a slim chance, changing laws before they're made is a hell of a lot easier than changing laws after they become laws. I will, of course, be keeping track of this and sharing resources where I can. For now, I want to say thanks again to my sponsors, nexus.io,

Starting point is 00:17:04 Arculus and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take you. care of each other. Peace. Hey, breakdown listeners. Come join CoinDesk's Consensus 2020, the festival for the decentralized world this June 9th through the 12th in Austin, Texas. This is the only festival showcasing and celebrating all sides of blockchain, crypto ecosystems, Web 3, and the Metaverse, and is designed for crypto newbies, investors, entrepreneurs,

Starting point is 00:17:35 developers, and creators. Don't miss speakers like Kathy Wood, SBF, CZ, Punk 6529. and Joe Lubin to name just a few. Use code breakdown to get 15% off your pass at coindesk.com slash consensus 2022.

The Breakdown - The European Union vs. Self-Hosted Crypto Wallets

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