Why the Focus on Self-Hosted Wallets?
More countries are implementing the Financial Action Task Force’s (FATF) Travel Rule or their own variation thereof. With each implementation, there is a growing focus on self-hosted wallets to combat money laundering and terrorism financing.
Europe’s version of the Travel Rule, the Transfer of Funds Regulation (TFR), requires crypto asset service providers (CASPs)* to apply enhanced due diligence measures when transactions involve self-hosted wallets. Ownership is to be collected when:
the transaction exceeds EUR 1000,
or the owner of the wallet is the CASP’s customer.
for transfers to or from a self-hosted wallet belonging to an existing onboarded customer, VASPs will have to verify that the customer has the power of disposal over the assets held in the self-hosted wallet;
for transfers to or from a self-hosted wallet belonging to a third party, VASPs will have to verify the identity of the third party as well as establish the identity of the beneficial owner and verify that the third party controls the self-hosted wallet.
These are just 2 examples of regulations surrounding self-hosted wallets; different jurisdictions have their own interpretations.
Additionally, studies show that experienced crypto users choose self-hosted wallets as a method for investment, and newer users opt for them to safeguard their assets, especially after the hacks and losses of 2022.
5 Quick Facts VASPs Should Know about Self-hosted Wallets
1. Self-hosted wallets go by many names: self-custodial wallet, non-custodial wallet, unhosted wallet, external wallet, private wallet, or crypto wallet.
2. Self-hosted wallets can be hardware or software used to store, hold or transfer virtual currencies. For a wallet to be self-hosted, the owner will have complete control over their private key. The TFR defines a self-hosted wallet as: "a distributed ledger address not linked to either of the following: a) crypto-asset service provider; b) an entity not established in the EU and providing similar services."
3. Various regulations, like the TFR, require CASPs to ascertain wallet ownership before transactions can be processed.
4. Wallet ownership can be ascertained in 4 ways. Through:
Address Ownership Proof Protocol (AOPP),
All of them will soon be supported by 21 Travel Rule. Check it out here.
5. Self-hosted wallets transacting directly with other self-hosted wallets will not have to adhere to the Travel Rule. Peer-to-Peer transactions are excluded from any regulations, as the technology used is not a regulated entity.
How Can VASPs Offer Frictionless Compliance?
With the growing global adoption of the Travel Rule and the various adaptations thereof, VASPs will have to relook at their Travel Rule compliance software. Moreover, if VASPs wish to retain existing customers, they will need to offer wallet verification options that keep their customers safe with an easy-to-use experience.
On top of this, these options need to be easy and quick to perform, privacy respecting and as low-cost as possible. Adhering to the different needs of VASPs, our wallet ownership-proof solution offers several verification methods. To be compliant, a VASP must assess the risks associated with its transactions involving self-hosted wallets and identify which method will have the least impact on its customers’ journey, as well as the compliance team’s day-to-day duties.
Our Travel Rule solution supports AOPP, the Satoshi Test, Manual Signing and Visual Proofs as verification methods, ensuring a better user experience for customers and VASPs. Irrespective of a VASPs favoured verification method, 21 Travel Rule supports it.
Each wallet verification method has its strengths and weaknesses; it’s important to note that one approach does not rule out the others. See a comprehensive breakdown below.
Find out more about 21 Travel Rule’s benefits today.
*VASP and CASP are used interchangeably throughout this text per the regulations being cited. Learn more about the differences between these service providers.