Delaying the inevitable by regulating self-custody wallets

In a tweet on Thanksgiving day, Tim Armstrong, CEO at Coinbase, posted that US Secretary of Treasury, Steven Mnuchin, is rumored to be working on a law to regulate self-hosted crypto wallets. Supposedly he’s rushing to wrap and deliver this law before the end of Donald Trump’s term of office on January 20, 2021. The proposed regulation will require exchanges to verify the identity of users who use self-hosted wallets, before a withdrawal could be sent to their self-hosted wallet. According, to John Bolton’s book, the former National Security Advisor claims that Trump told Treasury Secretary Steven Mnuchin in May 2018, to “go after Bitcoin”. Well, as expected the news triggered a lot of concern, and the price of bitcoin dropped by $3,000, before it rebounded above $18k. While the announcement of such regulation may have a short-term negative impact on prices, the long-term outcome doesn’t change, because bitcoin is linked to a new frontier, the digitization of money and value. In response the Blockchain Association released “Self-Hosted Wallets and the Future of Free Societies – A Guide for Policymakers”, a new report presenting policy options for self-hosted wallets to regulators. Coin Center published “How I Learned to Stop Worrying and Love Unhosted Wallets”, an expert opinion by Jai Ramaswamy (formerly the head of the Department of Justice’s Anti-Money Laundering division), also defending non-custodial crypto wallets. Both the Blockchain Association and Ramaswamy agree that AML is needed but for on/off ramps for fiat to crypto and vice versa. The essence of cryptocurrencies like bitcoin is that they allow anyone to have custody privacy and control over their digital assets. If US regulators did go down this path, they would be fighting against open source wallets and open source currencies, a difficult thing to do on many different levels.

Ilias Louis Hatzis is the founder and CEO at Kryptonio, a “keyless” non-custodial bitcoin and cryptocurrency wallet, that lets users manage bitcoin and crypto, without private keys or passwords.

Self-hosted crypto wallets or non-custodial crypto wallets are cryptocurrency wallets that let individuals and organizations store and use their digital assets, instead of having to depend on a third-party financial institution to store their coins. Users can create a wallet by downloading third-party software on their computers and mobile phones or through hardware devices that store digital assets.

There are many types of wallets that range from full-custody to self-custody wallets. Most cryptocurrency users, store their bitcoin on exchanges or hot wallets because of the ease they offer, but also have a history of being hacked. Smarter and more experienced users, use self-custody or hardware wallets that let them manage the private keys of their bitcoin.

In the past, when bitcoin faced regulatory uncertainty, its price skyrocketed. Last time it happened was in 2017 when China announced it would ban bitcoin. This time around it’s the US beating the drum.

If the rumor Armstrong tweeted about becomes a reality, there could be several cases that are affected:

  1. Sending crypto to smart contracts to use DeFi apps. Smart contracts are not necessarily owned by any individual or business that could be identified.
  2. Paying online merchants using crypto, and require customers to verify the identity of businesses before they can buy a product.
  3. Sending crypto to people in emerging markets, where it may be difficult to collect information about the recipient, since people may not have a permanent address or identity documents.
  4. Sending crypto to people in developed markets who value their financial privacy and may not want to upload  identifying documents to receive the cryptocurrency.

Why is this a big deal?

Governments want to be in full control of monetary policies, because this gives them power to govern. In times of crisis, like we are facing now with the coronavirus pandemic, being in control allows them to print money and hand out stimulus to people and businesses. But this is a losing and near-sighted strategy.

If this regulation comes to pass, it would instantly increase the demand for DEXs and create two markets. On one side you will have users that relinquish all their privacy to centralized services and on the other you will have “orthodox” believers of the original principles of crypto.

Bitcoin’s growing popularity poses a risk to the traditional banking system. Mnuchin is only trying to delay the inevitable and give banks more time, to figure out their next step. The U.S. must recognize that strong financial technology companies are a matter of national security. But technology alone is not enough. Supportive regulations for bitcoin and cryptocurrencies is essential.

The existing financial and banking system is based on antiquated models and technologies and faces dramatic change from digital wallets, blockchain technology and cryptocurrencies that are coming from everywhere around the world. Regulation needs to get in tune with the times.

The rumor about this regulation, only puts the US at risk, as a financial and innovation hub. Unfortunately, this opens the door for other countries to become “friendlier” and dominate future innovation. Instead of embracing openness and the values that allowed the U.S. to dominate the global market in the Internet era, the US. is taking a tough stance. The reality is that the USA is not nearly as relevant in the crypto markets as most people think. The EU and Asia are already the main drivers for crypto adoption. Binance has over $13 billion in spot volume, while rejecting customers from the US.

The US needs to change its strategy, understand that bitcoin and cryptocurrencies are the new frontier and play the long game to maintain its lead.

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