Enhancing User Trust: the Role of Compliance in Wallet Provider Services

The digital wallet landscape has been undergoing a big shift in recent years, with the emergence of cryptocurrencies and blockchain technology. However, the industry is currently facing a lot of challenges, particularly when it comes to compliance and regulation. While on the one hand, it’s understandable because the industry is in its infancy, it only highlights the urgent need for better compliance in order to gain user trust.

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The Importance of Trust

People want their money to be safe, and so trust is the cornerstone of any financial transaction. In traditional financial systems, this trust is often established through legal and institutional frameworks. For example, it’s difficult to consider a safer way to transfer money than through SEPA. 

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However, when it comes to digital wallets and cryptocurrencies, trust is often placed in technology rather than institutions. While logical to an idealist, it’s proven to not be enough in practice. This shift necessitates stringent compliance regulations to ensure that the technology is as secure and reliable as possible.

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Trust and Compliance: Two Sides of the Same Coin

The FTX scandal serves as a cautionary tale. The platform collapsed due to the mismanagement of funds, lack of liquidity, and a large volume of withdrawals. Compliance wallet providers were at an all-time low. This led to a loss of billions of dollars for customers and investors alike. 

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Such incidents erode public trust and highlight the need for robust compliance mechanisms. Without compliance, there's no assurance for consumers that their funds are safe, which in turn affects the adoption rate of digital wallets and cryptocurrencies.

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Key Regulations for Wallet Providers

In the UK, the Financial Conduct Authority (FCA) plays a pivotal role in regulating crypto asset providers, including those offering wallet services. The FCA's primary focus is to ensure that these entities have robust Anti-Money Laundering (AML) and Counter-Terrorism Financing (CTF) protocols in place. Though, more recently, they’re also interested in protecting consumers against exploitative and risky marketing promotions.

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Foundational Legislation

The cornerstone of AML/CTF regulation in the UK is the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, commonly referred to as MLR 2017. This legislation has undergone several amendments to align with evolving international standards, such as the EU's Fifth Anti-Money Laundering Directive (AMLD5) and the recently incorporated Travel Rule.

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Classification of Companies

MLR 2017 distinguishes between two categories of companies: crypto asset service providers and custodian wallet providers. The former encompasses firms involved in crypto-to-crypto or crypto-to-fiat exchanges, while the latter focuses on companies that offer secure storage and management services for crypto assets.

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Registration Prerequisites

For companies dealing with security tokens, FCA registration is mandatory as these are classified as "regulated tokens." Conversely, firms handling exchange and utility tokens are not obligated to register but must meet certain criteria. These criteria include the company's advertising practices, the benefits derived from crypto asset services, and whether the company has a UK-based operation involved in crypto activities.

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AML Compliance Measures

AML compliance is non-negotiable and involves the appointment of a Money Laundering Reporting Officer (MLRO). The MLRO is tasked with overseeing AML training for staff and conducting risk assessments. Companies are also required to perform customer due diligence, which varies in intensity from Simplified Due Diligence (SDD) to Enhanced Due Diligence (EDD). Continuous monitoring of customer transactions is needed for identifying and reporting suspicious activities. While some regulations protect consumers, AML protects entire countries.

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The Travel Rule

Effective from the 1st of September 2023, the UK will enforce the Travel Rule, requiring crypto businesses to collect and share information about both the sender and receiver in crypto transactions. This is aimed at increasing transparency in crypto transactions.

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Upcoming Regulatory Changes

The UK Government continues to work on further regulating the crypto industry. Future plans include tightening up regulations for crypto trading platforms, introducing a framework for crypto lending, and implementing protective measures against market manipulation. Additionally, the scope of regulated crypto activities is expected to broaden, which will potentially include activities involving stablecoins.

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Noncompliance and the FCA’s Final Warning Letter

The FCA has issued stern warnings to cryptoasset firms in a recent letter about the consequences of non-compliance, particularly in marketing to consumers. The agency's final warning serves as a critical juncture, marking a transition from mere oversight to active enforcement. 

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This letter is not just a cautionary note but a clear signal that the FCA is prepared to take stringent actions against non-compliant entities. It outlines the agency's expectations and serves as a last opportunity for firms to align their operations with regulatory standards. 

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The letter underscores the FCA's commitment to consumer protection, emphasising that misleading marketing practices will not be tolerated. Firms are warned that failure to adhere to these guidelines could result in a range of punitive measures. The bottom line is that firms may receive hefty fines, the revocation of operating licences, and even criminal prosecutions. 

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In essence, the letter amplifies the financial and reputational risks associated with non-compliance. Beyond the financial implication of a fine or revocation of a licence is, of course, the bad PR that comes with it. And, once a crypto provider gains bad PR, it’s very difficult to shake. In fact, scrutiny from regulators sparked a panic for Binance users, who subsequently tried to withdraw $1.9 billion in 24 hours at the end of last year—that could have spelled big trouble.

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The Economic Crime and Corporate Transparency Bill further intensifies the regulatory landscape. It aims to strengthen the UK's fight against economic crime and includes amendments to enable law enforcement to more effectively seize and recover cryptoassets. Non-compliance could lead to asset forfeiture and even the destruction of cryptoassets in exceptional circumstances.

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Final Word

In an industry marked by rapid innovation and regulatory scrutiny, compliance and trust are paramount for wallet providers. The FCA's evolving guidelines and the looming Economic Crime Bill underscore the urgency. For those seeking expert guidance in navigating this complex landscape, at Englebert, we specialise in crypto regulation and offer comprehensive compliance solutions and training to ensure your operations remain trusted by all current and future users. Get in touch with us today.

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