Right after the European crypto industry had averted the combined attack of the Green Party, Social Democrats and the Left-Wing Party in the European Parliament on the PoW consensus-mechanism with a narrow majority, new drama is on the horizon. An amendment to the European Funds Transfer Regulation has been proposed, which not only obligates crypto service providers in the European Union to verify the identities of the owners of all involved crypto wallets of a crypto transaction, but also prohibits crypto service providers to allow transfers to wallets which do not allow these identification procedures. The proposal is intended to prevent anonymous transactions involving crypto assets in the regulated financial system of the European Union. It especially aims at ridding money launderers, financiers of terrorism and other crooked market participants of the option to move wealth in crypto assets around and afterwards transfer it back into the regulated financial system. A conversion of crypto into fiat money via a crypto exchange will only be possible for completely identified users, should the aforementioned proposal be adopted, because crypto exchanges will be supervised institutes in Europe as soon as the Markets in Crypto Assets regulation (MiCA) goes into effect.

European Parliament Adopts the Proposal – Trilogue Negotiations Ahead

Last week, the EU parliament voted in favor of the proposed amendment to the European Funds Transfer Regulation with a narrow majority. Nevertheless, the amendment is not yet finally adopted, because the draft bill now must be negotiated and adopted in the so-called trilogue negotiations between the EU parliament, the EU commission and the council of the European Union before it can come into effect. The European crypto industry fears that the usage of crypto assets in most parts of Europe will only be possible when utilizing an authorized and supervised crypto service provider, should the current version be adopted. The crypto service providers fear the enormous administrative effort connected to the proper identification and verification of every party involved in every transaction. This regulation may be a potential showstopper for the connection between the centralized financial system and the decentralized crypto market. This is especially true for so-called unhosted Wallets, meaning crypto wallets that are not operated by an authorized provider, but instead are operated privately or in a decentralized way.

What Are the Implications of the New Regulation for Private, Unhosted Wallets?

With regards to privately managed wallets, it should also in future be possible for operators to identify the respective private person and verify their identity, in case that the proposal is passed. The self-custody option for crypto assets would therefore not necessarily be endangered. From a practical point of view it would nevertheless imply a cost-intensive effort for many operators to identify and verify every private wallet. Operators could therefore come to the business decision to exclude unhosted wallets from transactions altogether. Crypto users could therefore be forced to solely utilize authorized crypto custody service providers which would constitute an additional third-party risk with regards to the “not your keys – not your cryptos” principal. In summary, the regulation would once again lead to a substantially more centralized crypto market. The technical innovation of the blockchain technology, meaning the ability to conduct decentralized transactions without the necessity of a service provider acting as an intermediary would thereby again be heavily reduced.

Attorney Lutz Auffenberg, LL.M. (London)

I.  https://fin-law.de

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