Hosting a cryptocurrency wallet means storing a user’s digital assets (i.e. cryptocurrencies) on a server or other digital storage device that is managed by a third-party service provider. Cryptocurrency wallets are digital wallets that allow users to securely store, manage, and transfer their cryptocurrencies. These wallets can either be software-based, such as desktop or mobile applications, or hardware-based, such as physical devices that can be connected to a computer or mobile device. Hosting a cryptocurrency wallet means that the user entrusts their private keys (which allow them to access and manage their cryptocurrency) to a third-party service provider. The provider is responsible for the security of the wallet, ensuring that the user’s funds are safe and secure from theft, loss, or other security breaches.
Cryptocurrency exchanges, for example, often offer wallet services to their users, allowing them to store and manage their cryptocurrency holdings within the exchange’s platform. There are also dedicated wallet service providers, which offer specialized wallet solutions and additional features, such as multi-signature authentication and cold storage options.
The legal requirements for hosting cryptocurrency wallets can vary depending on the jurisdiction and the type of wallet service being offered. However, in general, wallet providers must comply with the following legal requirements:
- Registration and licensing: Some jurisdictions may require wallet providers to register or obtain a license to operate as a money services business (MSB) or virtual currency business.
- Anti-money laundering (AML) and know-your-customer (KYC) requirements: Wallet providers may be required to implement AML and KYC policies and procedures to prevent their services from being used for money laundering or terrorist financing.
- Consumer protection: Wallet providers must adhere to consumer protection laws and regulations, such as those related to privacy, data protection, and customer disclosures.
- Taxes: Wallet providers must comply with tax laws and regulations related to cryptocurrency activities, including reporting requirements for income and capital gains.
- Security requirements: Wallet providers must take appropriate measures to protect customer funds and data, such as implementing strong encryption, conducting regular security audits, and maintaining adequate cybersecurity measures.
- Compliance with international sanctions: Wallet providers must comply with international sanctions and restrictions related to cryptocurrency activities, such as those related to countries or individuals subject to sanctions.
In the United States, wallet hosting services must register as Money Services Business with the Financial Crimes Enforcement Network (FinCEN). FinCEN has provided wallet hosting services with specific guidance on complying with Bank Secrecy Act rules and regulations.
Here are some key points from FinCEN’s guidance on cryptocurrency wallet hosting:
- Registration as a money services business (MSB): Virtual currency businesses, including those that provide wallet hosting services, are considered MSBs under the BSA and must register with FinCEN and comply with its regulations.
- AML and KYC requirements: Wallet providers must establish and implement AML and KYC programs, which include procedures for customer identification, transaction monitoring, and suspicious activity reporting.
- Reporting requirements: Wallet providers must report certain transactions and suspicious activity to FinCEN, including transactions over a certain threshold and transactions that are suspected to be involved in money laundering or terrorist financing.
- Recordkeeping requirements: Wallet providers must maintain records of customer transactions, identification information, and other relevant data, which must be made available to law enforcement upon request.
- Compliance program requirements: Wallet providers must establish and implement a comprehensive compliance program that includes policies and procedures, internal controls, and ongoing training and education for employees.
More specifically, FinCEN has applied stringent requirements around AML and KYC protocols, including:
- Customer identification: Wallet providers must establish procedures for verifying the identity of their customers. This includes obtaining and verifying identifying information, such as name, address, and date of birth, as well as checking for any adverse information about the customer.
- Transaction monitoring: Wallet providers must implement systems for monitoring customer transactions for suspicious activity, including large or unusual transactions, and take appropriate action when suspicious activity is detected.
- Suspicious activity reporting: Wallet providers must report suspicious activity to FinCEN using the Suspicious Activity Report (SAR) form. This includes any transactions that the wallet provider suspects may be involved in money laundering or terrorist financing.
- Recordkeeping: Wallet providers must maintain records of all customer transactions, including the parties involved, the amount, and the date and time of the transaction. These records must be maintained for a minimum of five years.
- Compliance program: Wallet providers must establish and maintain a written AML program that includes policies, procedures, and internal controls for ensuring compliance with AML and KYC requirements.
On the state level, the hosting of cryptocurrency wallets will generally require a money transmitter license. Although a few states have enacted specific legislation which places enhanced regulation on cryptocurrency wallet providers:
- New York: In 2015, the New York State Department of Financial Services (NYDFS) implemented the BitLicense, which requires any business engaging in virtual currency activities, including hosting cryptocurrency wallets, to obtain a license and comply with certain AML, KYC, and cybersecurity requirements.
- Texas: In 2019, Texas passed the Texas Virtual Currency Bill, which provides a legal framework for the use of cryptocurrencies and blockchain technology in the state, and defines virtual currencies as a form of money under Texas law.
- California: In 2018, California passed the Virtual Currency Business Act, which requires businesses engaged in virtual currency activities, including hosting cryptocurrency wallets, to register with the state’s Department of Business Oversight and comply with certain AML, KYC, and consumer protection requirements.
Across the globe, the regulation of hosting cryptocurrency wallets varies.
In the United Kingdom, cryptocurrency wallet hosting providers are subject to certain licensing requirements under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs). The MLRs implement the European Union’s Fifth Anti-Money Laundering Directive (5AMLD) and apply to cryptocurrency businesses, including wallet providers, as well as other types of financial institutions. Under the MLRs, cryptocurrency wallet hosting providers are considered “cryptoasset exchange providers” and are required to register with the Financial Conduct Authority (FCA) and comply with AML and KYC requirements.
In the European Union (EU), cryptocurrency wallet hosting providers are subject to certain licensing requirements under the Fifth Anti-Money Laundering Directive (5AMLD), which was implemented in January 2020. The 5AMLD aims to combat money laundering and terrorist financing and applies to cryptocurrency businesses, including wallet providers, as well as other types of financial institutions.
Throughout the Caribbean, the licensing requirements for cryptocurrency wallet hosting providers can vary depending on the specific jurisdiction. Some countries in the Caribbean have enacted laws and regulations related to cryptocurrency activities, while others may have yet to develop a comprehensive regulatory framework for this emerging industry. For example:
- Bermuda: The Digital Asset Business Act 2018 requires businesses engaged in digital asset activities, including cryptocurrency wallet hosting, to obtain a license from the Bermuda Monetary Authority and comply with AML and KYC requirements.
- Cayman Islands: The Cayman Islands Monetary Authority has issued guidance that requires virtual asset service providers, including cryptocurrency wallet providers, to register with the authority and comply with AML and KYC requirements.
- Jamaica: Jamaica has not yet enacted comprehensive regulations specific to cryptocurrency activities. However, the Bank of Jamaica has issued guidance that indicates that businesses engaged in virtual currency activities, including wallet hosting, may be subject to AML and KYC requirements under existing legislation.
- Bahamas: The Central Bank of the Bahamas has issued draft regulations for digital asset service providers, which include cryptocurrency wallet hosting, that require licensing and compliance with AML and KYC requirements.
Today, there are few jurisdictions that fail to regulate the hosting of cryptocurrency wallets. Thus, the analysis of where to locate your operation is dependent upon the ease of compliance with local law together with the target market for your services.
About Adam Tracy
Adam Tracy is a payments expert and entrepreneur who specializes in payment systems, blockchain technology, digital currencies, and other emerging technologies. He is the founder of Blockrunner, LLC that provides consulting services to clients in the blockchain, payments and cryptocurrency arenas.
Tracy has been involved in the blockchain, payments and cryptocurrency space since 2013, and he has worked with a wide range of clients, including startups, established businesses, and investors. He has advised clients on legal and regulatory issues related to initial coin offerings (ICOs), cryptocurrency exchanges, regulatory licensing, smart contracts, and other blockchain applications.
In addition to his consulting work, Tracy has founded several companies in the blockchain and cryptocurrency space, including a digital asset hedge fund and a blockchain-based tokenization platform. He is also a proponent of decentralized finance (DeFi) and has been involved in various DeFi projects.
Tracy is also a frequent speaker and writer on blockchain and cryptocurrency topics. He has been featured in a wide range of publications, including Forbes, CoinDesk, and Bitcoin Magazine.
Find Adam: https://linktr.ee/adamtracy