AML Compliance for Non-Custodial Wallets

With the growing popularity of cryptocurrencies, it has become crucial to establish strong regulations and strategies to combat money laundering and illicit activities. One area that demands attention is the compliance obligations associated with non-custodial wallets. Non-custodial wallets offer users greater control over their digital assets, but do they need to comply with anti-money laundering (AML) regulations? In this article, we will explore the concept of non-custodial wallets and delve into the significance and challenges of AML compliance within this domain.

Unhosted wallets, also known as self-custodial or user-controlled wallets, are digital wallets that allow users to store and manage their own cryptocurrencies without relying on a third-party custodian. With unhosted wallets, users have complete control over their private keys, and they are responsible for the security of their own funds. Examples of unhosted wallets include cold wallets, for instance Ledger and Trezor, as well as software wallets like Exodus or Metamask.

Non-custodial wallets act as software interfaces for managing the blockchain addresses associated with the user's assets. A significant challenge in achieving AML compliance for unhosted wallets stems from their decentralized nature, lacking centralized control.

Unlike custodial wallets, unhosted wallets do not require users to undergo know-your-customer (KYC) procedures before utilizing them. This feature makes it easier to transfer illicit virtual assets without traceability. Hence, the question arises: do non-custodial wallets fall within the scope of AML compliance?

Recognizing the risks associated with transactions involving virtual assets (VAs) to and from unhosted wallets, the Financial Action Task Force (FATF) has provided guidelines on AML compliance for virtual asset service providers (VASPs). These guidelines introduce a "travel rule" that mandates VASPs to collect and transmit customer information for transactions above a certain threshold.
Under the travel rule, VASPs must gather and verify the sender and recipient's name, address, and account number. This information must be shared upon request from another regulated entity, whether it's a VASP or a financial institution. Importantly, the FATF states that the obligation to collect "travel rule" data extends to transfers between VASPs and non-regulated entities like non-custodial wallets. Consequently, VASPs have a responsibility to identify holders of non-custodial wallets. However, the decentralized nature of non-custodial wallets presents challenges in effectively enforcing the travel rule.

While non-custodial wallets themselves may not require AML compliance, there are ongoing discussions and efforts to improve AML measures within the cryptocurrency ecosystem. Moreover, regulatory bodies in different jurisdictions have repeatedly stated that there is a need to make non-custodial wallets more transparent and to identify all holders of such wallets.

To navigate the evolving regulatory environment and adhere to relevant guidelines, it is crucial for users and businesses involved in cryptocurrency transactions to stay informed. BitOK offers a solution set that can help mitigate ML/TF risks and satisfy crypto AML requirements.

Discover how BitOK can automate your AML & KYT compliance by requesting a demo today.