FinCEN Proposes New Rule for Crypto Wallets, Aims to Enhance AML Standards

FinCEN Proposes New Rule for Crypto Wallets, Aims to Enhance AML Standards

The U.S. Financial Crimes Enforcement Network (FinCEN) has proposed a significant regulatory change aimed at strengthening the anti-money laundering (AML) framework for cryptocurrency transactions. The proposed rule, titled “Requirements for Certain Transactions Involving Convertible Virtual Currency or Digital Assets,” is designed to improve the transparency and accountability of transactions involving unhosted wallets, commonly known as self-hosted wallets.

This rule mandates that businesses engaged in the transfer of digital assets, including cryptocurrency exchanges and money services businesses (MSBs), maintain detailed records and submit reports on transactions involving unhosted wallets. The proposed regulations seek to enhance compliance with AML standards and reduce the risk of illicit activities such as money laundering, terrorism financing, and other financial crimes in the growing crypto ecosystem.

What Are Unhosted Wallets?

In the context of the proposed rule, unhosted wallets refer to wallets where users control their private keys and are not managed by third-party services like exchanges or custodial wallet providers. These wallets can be software-based or hardware-based, and they allow users to store and trade cryptocurrencies without the intervention of a centralized platform.

According to FinCEN, unhosted wallets are a potential risk factor for financial crime because transactions involving these wallets can be conducted without proper oversight or verification of the parties involved. As a result, the new rule seeks to impose stricter reporting requirements for transactions between exchanges and unhosted wallets, with a particular focus on increasing transparency.

Key Provisions of FinCEN’s Proposed Rule

The proposed rule introduces several key provisions aimed at enhancing transparency in cryptocurrency transactions:

1. Record-Keeping and Reporting Obligations:

   • Exchanges and MSBs will be required to gather, store, and share detailed information about customers who send cryptocurrency to unhosted wallets. This includes the names, physical addresses, and transaction details of both the sender and recipient.
   • Exchanges would also need to report transactions over $10,000 to FinCEN, aligning with the Financial Action Task Force’s Travel Rule, which requires exchanges to share the identity of the sender and beneficiary in large transactions.

2. Know-Your-Customer (KYC) Requirements:

   • For transactions greater than $3,000, businesses would need to verify the identities of their customers, further tightening the KYC standards.
   • This would help ensure that exchanges and wallet services have accurate and up-to-date records of their users, reducing the risk of anonymity in transactions.

3. Dealing with Structuring:

   • The rule also addresses structuring, which involves breaking large transactions into smaller amounts to avoid reporting obligations. The proposed regulations would prevent this behavior by requiring businesses to report transactions even if they are artificially divided to bypass the $10,000 threshold.

4. Impact on Cryptocurrency Users and Businesses:

   • Cryptocurrency exchanges and wallet providers will be required to adapt their systems to comply with these new rules. This could result in more stringent verification processes for users sending cryptocurrency to unhosted wallets.
   • For individual users, the changes may mean greater scrutiny of their transactions, particularly if they regularly send large amounts to unhosted wallets.

Industry Reactions to the Proposed Rule

The cryptocurrency industry has expressed mixed reactions to the proposed rule. On one hand, the rule is seen as a necessary step toward increasing regulatory clarity and legitimacy in the crypto space, especially as digital assets become more integrated into the global financial system.

On the other hand, some critics argue that the rule may place an undue burden on cryptocurrency businesses and could undermine the core principles of privacy and decentralization that blockchain and crypto technologies aim to uphold. Brian Armstrong, the CEO of Coinbase, raised concerns in a November tweet, suggesting that the rule could be more stringent than initially expected, potentially making it harder for users to interact freely with their crypto assets.

While FinCEN acknowledges these concerns, the agency emphasizes that the need for such regulation is growing, given the increasing adoption of cryptocurrency and its potential use for illicit activities. FinCEN views this move as part of a broader effort to ensure that cryptocurrency remains compliant with the same AML standards that apply to traditional financial systems.

Public Comment Period and Next Steps

The public has until January 4, 2021, to submit written comments on the proposed rule. These comments will help FinCEN refine and finalize the regulations before they are enacted. Once the rule is finalized, cryptocurrency exchanges and MSBs will need to implement the required changes to their compliance frameworks.

In the meantime, businesses and individual users in the crypto space are advised to monitor these developments closely, as the final rule could significantly impact how cryptocurrency transactions are conducted in the U.S.

Conclusion

The FinCEN proposed rule marks a significant shift in the regulatory landscape for cryptocurrency, particularly when it comes to unhosted wallets. While it seeks to enhance AML compliance and increase transparency in the crypto space, it also raises important questions about privacy and the future of decentralized finance.

As the cryptocurrency industry continues to grow, it is likely that more regulatory frameworks will emerge to address the unique challenges posed by digital assets. For now, FinCEN’s proposed rule represents a crucial step toward integrating cryptocurrency into the broader financial regulatory system.

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