Complying with National Regulators: Case of Non-custodial Wallets
by Spatium Team on Nov 1, 2023 11:12:27 AM
Many have witnessed that the crypto sphere is going through a rough period of its development. Early adopters of blockchain were idealistically dreaming about a new financial world with minimum or no regulations, anonymity, and total freedom. In reality, things don’t always turn the way we want. Crypto mass adoption and the growing involvement of traditional businesses dictate terms and the crypto world is becoming more regulated.
What is the Status of Crypto?
With the growing adoption of crypto, national governments all around the world are changing their legislation systems concerning crypto assets. For example, the USA classifies crypto as a commodity, while some digital assets and tokens are even recognized as securities. Such countries as China, Singapore, and Great Britain determine crypto as property. Japan and Australia went further and recognized crypto as legal property. The majority of other countries either haven't made up their mind abиout it or are looking in the direction of crypto regulations.
Based on the fact that many governments around the world have recognized the legal status of crypto assets, crypto projects, exchanges, and crypto assets service providers are facing a hard dilemma.
On the one hand, they have the perspective of growing and gaining benefits of web3.
On the other hand, it’s difficult to comply with regulations. They have to provide documentation, licenses, and legal counseling engagement which is eating the company’s funds and time. Not to mention that national regulators are stealing from their users a chance to stay financially free and anonymous, which web3 was initially about.
Spatium is proud to announce that we know how to cut this Gordian knot. But let’s start from the top and shed some light on the challenges existing in web3 and how national regulators are trying to stop illegal activity there.
What Rumbles the World of Web3?
1. Money Laundering (ML)
Due to the decentralized and anonymous nature of web3, there is a higher risk for transactions supporting illegal actions. This problem is rooted in their anonymous nature when no one can tell where the assets come from and who is the holder of funds. That’s why various money laundering schemes exist. And national legal bodies all over the world work around Anti-Money Laundering (AML) regulations.
2. Terrorism Financing (TF)
Combating the financing of terrorism (CFT) is another approach national regulatory executives are actively developing. Terrorist activity is increasing all over the world and web3 is often spotted as a convenient ecosystem to perform illegal transactions including the support of different terrorist groups.
Since 2008, when the first blockchain was created, it has grown in size. Various new blockchains originate. This led to the growth of the web3 market size which is now around 3.25 billion dollars. National governments are interested in the introd34uction of a tax for companies and users operating in the crypto sphere. Some countries that recognize crypto as a commodity, introduce the same tax as for other types of commodities.
Other countries, which are still developing a holistic approach to crypto taxation, set different tax limits. For example, India introduced a 30% tax on crypto investments. The EU gives freedom to each of its members on the tax range, so it can be anything from 0% to 50%.
Top World Web3 Regulators
Probably one of the most heavily crypto-regulated countries in the world is the USA. The country has developed a board network of crypto market regulators. Securities and Exchange Commission (SEC), Financial Crimes Enforcement Network (FinCEN), and Community Futures Trading Commission (CFTC) just to name a few. It’s quite understandable. The biggest user penetration in the crypto sphere, which is 22%, is in the USA, while global user penetration is only 8%.
2. European Union
In June 2023 European Union introduced the Markets in Crypto-Assets Regulations (MiCA) framework which embedded six Anti-Money Laundering Directives issued earlier. They target the protection of consumers in web3 and introduce new licensing requirements. MiCA will be activated and applied to crypto players at the end of 2024. It means that until that time each EU country keeps its national crypto regulations. After 2024 the regulators operating on the territories of the EU should comply with the MiCA framework.
3. Other Countries
In Canada, a country that is quite proactive toward crypto, there are two main regulators: the Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Securities Administrators (CSA).
In the United Kingdom, the Financial Conduct Authority (FCA) is responsible for checking if crypto asset providers comply with the existing AML/CFT regulations. Also, if an exchange or crypto wallet provider suspects any suspicious activity, they have to notify the Office of Financial Sanctions Implementation (OFSI) as soon as possible.
In Japan and Australia, all crypto exchanges should be registered with national regulators and comply with AML/CFT requirements. A similar situation is seen in many other countries: Brazil, Singapore, India, South Korea, etc.
How Do National Regulators Approach Non-custodial Wallets?
The good news for all non-custodial wallet providers is that in the majority of countries non-custodial wallets are not regulated. At least, that’s the situation we witness right now. The recent attempt to bring more control over non-custodial wallets was taken by FinCEN (USA) in December 2020. The proposal was harshly criticized by the crypto community and was withdrawn a year later. Even such a powerful international organization as the Financial Action Task Force (FATF) hasn’t come up with a legal solution to introduce any regulations on non-custodial wallets.
As stated in the recent study: ‘The absence of technological solutions to ensuring FATF's ‘Travel Rule’, the problem of ‘unhosted (*non-custodial) wallets’, [and] the fact that P2P transactions do not involve any entity subject to AML-CFT regulations’ take them off the regulatory field.
The fact that non-custodial wallets are user-controlled and users only can initiate the transaction, approve or reject it, means that users are the custodians of their assets. From that perspective regulations which are introduced to protect consumers in web3 are excessive.
Some regulators claim that their policies facilitate web3 global adoption meaning the merging of web2 and web3 financial worlds. That’s true but if the wallet transaction activity doesn’t leave the solid well-protected walls of the web3, it is safe and no regulations are imposed either on users or non-custodial wallet providers.
Anyway, if you are located in the USA and would like to set up a crypto wallet company that will be making transactions with fiat, then it’s important to get to know more details about the regulations existing in the USA.
Licensing Peculiarities in the USA
Probably, the USA is the most complicated country regarding crypto licensing, or in other words, the one to be heavily regulated. First of all, each of the states have their own regulations, recognized on the state level. Secondly, all state-local crypto wallet providers should comply with federal laws as well.
That’s why there is never one license to obtain. I would say in general crypto wallet providers should get around 2-3 licenses to operate in the USA. All of them are expensive and take a lot of time to get. This is applied to custodial wallet providers, crypto exchanges, and non-custodial wallet providers who perform fiat transactions.
The majority of crypto businesses in the USA are recognized as money transmitters. Money transmitters and other businesses dealing with finances are categorized as Money Service Businesses (MSBs). The main body to regulate the activity of MSBs is the Financial Crimes Enforcement Network (FinCEN).
There are two main licenses a crypto wallet business might obtain: the MSB License (MSBL) which has to be renewed every 2 years and the Money Transmitter License (MTL), which might differ from state to state. For detailed information, it’s better to consult with a legal professional.
Also, for any financial activity, a business should comply with Bank Secrecy Act (BSA) regulations. It means that AML and KYC requirements should be met.
In addition to the MSBL and MTL, some crypto wallet providers operating in the USA might need other licenses:
Securities Broker-Dealer License: If a wallet is offering crypto that is recognized as security, then they have to comply with United States Securities and Exchange Commission (SEC) regulations as well. One of the examples of crypto which is recognized as a security are tokens issued during ICOs.
Commodity Trading Advisor (CTA) License: Crypto is recognized as a commodity in the USA which is why if any crypto wallet provider offers education materials on trading and provides any of the consulting or advisory functions, then, they probably have to obtain a CTA license.
In addition to all of that, crypto in the USA is subject to tax returns, it means that businesses as well as individuals should comply with the regulations issued by the Internal Revenue Service (IRS).
For any state-specific information, you have to consult with an attorney or a lawyer specializing in crypto wallet providers' legislation and regulatory compliances.
Based on how difficult the regulatory sphere is in the USA, it can be a solid idea to investigate other options worldwide to register your business.
Some of the most crypto-welcoming countries are Malta, Singapore, Germany, Estonia, etc.
Spatium Hybrid Solution
Spatium is an IT company, providing non-custodial Wallet as a Service software operating on MPC cryptography. We help businesses swiftly deploy user-friendly crypto wallets and concentrate on strategic business goals rather than tedious development routines.
Based on our unique technology and crypto wallet encryption implementation logic we assist our clients in two main ways:
1. Crypto Wallet for Web3 Interaction Only
Wallets built by Spatium don’t require crypto asset providers to obtain licenses to operate them. Starting from the day a business contacts Spatium to the product release date, the development takes less than a month.
2. Crypto Wallet for Web2/Web3 Interaction
Spatium provides Wallet as a Service components to develop advanced non-custodial wallets. As we have stated above, if a non-custodial wallet is used to sign transactions, connect to dApp and DeFi functionality, and store NFT and other assets it’s more likely that it doesn't have to comply with any regulations. But if a wallet provider wants to connect the wallet services to the financial world of web2, then it’s better to consult with local legal advisors on the existing national regulations.
If in the country where the business is registered new regulation rules emerge, Spatium SDK could be easily integrated with AML providers and co-sign the approved transactions only.
Many things are happening in web3: it’s developing, growing, and maturing. That’s why it has become a spot of interest for traditional businesses. And anywhere they go, they are affecting the existing matter of things. Crypto, which once had anonymous status, was brought to the legal field and started to be regulated in many countries worldwide.
Non-custodial wallet provided by Spatium is engaging, easy to use, and at the same time secure. Such an option could be ideal to start a crypto business with minimum investment. After a while, when a business has a greater audience and would like to start offering advanced services connected with traditional financing spheres, it’s important to make a deep research of the regulation requirements and apply for licenses and certifications.
Contact us for more information, and get a friend in the crypto space who understands your pain and is eager to help.
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