How regulators got it wrong

The recent European Union proposal requiring centralized crypto exchanges and custodial wallet providers to collect and verify personal information about self-custodial wallet holders shows the dangers of recycling traditional finance (TradFi) rules and applying them to crypto without appreciating the conceptual differences. We can expect to see more of this as countries look to implement the Financial Action Task Force (FATF) Travel Rule, initially designed for wire transfers, to transfers of crypto assets.

The (missing) link between self-custody, control and identity

The aim of the proposed EU rules is “to ensure crypto-assets can be traced in the same way as traditional money transfers.” This assumes that each self-custodial wallet can be linked to someone’s verifiable identity and that this person necessarily controls the wallet. This assumption is wrong.

More users may also switch to peer-to-peer transactions and decentralized players to avoid the burdensome rules. While this could be beneficial for some users, the EU should encourage smooth interconnectivity between centralized and decentralized players and promote users’ freedom to choose how they want to transact.

The proposal has now moved to negotiations between the EU legislative bodies starting April 28, with the final text expected by the end of June. If the rule passes in its current form, there will still be a chance to review it within 12 months after its coming into force. However, we can’t rely on this — now is the time for the European crypto industry to coordinate and engage with policymakers. Instead of forcibly applying TradFi rules to a developing technology, we should promote outcome-based policies that allow the emergence of novel compliance solutions that respect how crypto works.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Natalie Linhart is a legal counsel at ConsenSys, where she advises on products including MetaMask, NFT experiences and institutional staking. She also focuses on European regulatory issues affecting the crypto industry. She previously worked as a financial regulatory and derivatives lawyer at Clifford Chance London, advising clients on launching financial products, accessing new markets and mitigating regulatory risks. She also worked on derivatives and debt capital markets transactions including at a global investment bank.