Non-custodial wallets are under threat

What is the difference between a custodial and non-custodial wallet? The prime difference between custodial and non-custodial cryptocurrency services is that the private key is managed by third parties in the former, whereas it is handled by users in the latter case.

The EU is proposing some regulatory changes regarding these wallets managed privately by users. On March 31, the European Parliament’s Committee on Economic and Monetary Affairs (ECON) approved provisions to Europe’s Transfer of Funds Regulation that restricts Virtual Asset Service Providers (VASPs) from transacting with unhosted wallets without verifying their owners’ identities beforehand. Furthermore, VASPs will be required to report all crypto transactions worth more than 1,000 EUR to relevant anti-money laundering authorities.

As Brian Armstrong, CEO of Coinbase says, “Imagine if the EU demanded your bank to report you to the authorities every time you paid your rent, simply because the transaction was over 1,000 Euros.” Armstrong also said that the regulation amounts to treating “every person who holds crypto differently from fiat.” And if you use Coinbase, or indeed any other centralized exchange, if you are being sent a transaction that is above €1,000 in value, “Coinbase will be required to collect, store, and verify information on the other party, which is not our customer, before the transfer is allowed.”

Patrick Hansen of Unstoppable Finance remarked, the upshot of such a piece of regulation would mean that transactions between non-custodial wallets and centralized exchanges “would become way more costly and burdensome” due to the data collection requirements.

Furthermore, Hansen pointed out that the databases storing names, home addresses, and other sensitive personal data would become the target of hackers and criminals, which could lead to increased incidents of hacking, phishing, and physical violence targeting crypto users. He also warned that the provisions of the regulations could have even more drastic effects in the future, namely that the EU Commission could “potentially move to impose an outright ban on transfers between VASPs and non-custodial wallets in the future.”

Fortunately, the legislation has not yet been passed, and a debate on it will start this April. Hansen is hopeful: “Individual voices from the council and commission make me optimistic that we can still achieve changes.” If the legislation does pass, cryptocurrency businesses will still have nine months to adopt plans to adopt and implement the regulation, and 18 months until they must ensure full compliance.

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