FinCEN Moves to Regulate Self-Custodied Crypto Wallets

On December 18, 2020, FinCEN published a 72-page document proposing money service businesses (e.g. including cryptocurrency exchanges) to gather information about users dealing with “unhosted” cryptocurrency wallets. You might be affected by this new rule (if passed) if you have a self-custodied wallet such as a Ledger, Trezor, Exodus, or other wallets you host on your computer/phone/paper.

$10,000 threshold for reporting

Under the proposed rules, FinCEN requires crypto exchanges to report transactions larger than $10,000 by filing a form similar to the Currency Transaction Report (CTR) that banks use. Information submitted to the FinCEN includes customer transactions as well as the counterparty’s name and physical address.

For example, if you withdraw one bitcoin (currently valued at $23,000) from an exchange to a self-custodial wallet like a Ledger hardware wallet, the crypto exchange will have to report that activity to the FinCEN by filing a form. This is similar to the rules that US banks follow today for cash transactions.

$3,000 threshold for record-keeping

Exchanges would also be required to keep detailed records of user transactions worth more than $3,000, that are connected to self-custodied wallets. These detailed records include:

1. The name and address of the user
2. Type of cryptocurrency
3. Amount of cryptocurrency
4. Date and time
5. Fair market value of the cryptocurrency
6. The name and physical address of each counterparty to the transaction
7. Any other information that uniquely identifies the transaction, the accounts, and parties involved
8. Any form relating to the transaction that is completed or signed by the financial institution’s customer.

For example, if you were to withdraw 5 ETH (currently valued at $3,275) from an exchange to your Trezor hardware wallet, the exchange would have to keep records of all the items mentioned above.

Implications of new FinCEN rules

FinCEN’s stated intention for proposing these new rules is to combat illicit activities conducted behind the shield of cryptocurrency. The report points out that 11.9% of overall market transactions volume, or $10 billion, in virtual currency activity conducted globally in 2019 was illicit. However, note that this is dramatically lower than the estimated 33% of USD transactions that are used for illicit activities today. By subjecting users to more stringent Know Your Customer (KYC) rules, FinCEN believes that illicit activities financed by cryptocurrencies will be significantly reduced.

Although the intentions may be noble, this proposed rule has received significant criticism from the crypto community. First, the proposed rule has been rushed into the introduction; it only offers 18 days (deadline January 4, 2021) for public comments. With the fast-approaching holiday season, it’s likely that this new proposed rule may not have sufficient time for valuable public comments.

Further, the real-world effectiveness of the proposed rule is still questionable. For example, these rules cannot be practically be implemented in the rapidly growing Decentralized Financial space because there are no central parties to follow the rules. Bad actors can easily circumvent the centralized exchanges to carry out illicit activities.

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.