Self-custody, control and identity: 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 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.
Related: Authorities are looking to close the gap on unhosted wallets
In TradFi, a bank account is linked to the verified identity of its holder, giving them control over that account. For example, sharing your online banking details with your partner doesn’t make them the account holder. Even if your partner changes the login details, you can regain control by proving your identity to the bank and having it reset the details. Your identity gives you ultimate control which cannot be permanently lost or stolen. Of course, in exchange for the bank’s custody protections, you lose self-sovereignty over your assets.
Self-custody of crypto assets is different. Control (i.e., the ability to transact) over the self-custodial wallet is held by whoever has the private keys to that wallet. Control is not linked to anyone’s identity and there is no one to prove your identity to. All you need is to download a piece of software and safely store
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