Why Self-Hosted Wallets Are Critical to the Future of the Crypto Economy

Today, the Blockchain Association published a report for policymakers that explains the fundamental role of self-hosted wallets in the cryptocurrency ecosystem and why they are important to the future of free societies. The report is divided into two sections: The first section describes what self-hosted wallets are, their role in the digital asset ecosystem, and the current regulatory framework for managing digital asset transactions involving self-hosted wallets. The second section argues that imposing restrictions on individuals’ ability to use self-hosted wallets would be misguided.

Self-hosted wallets allow individuals to engage in transactions over the internet on a peer-to-peer basis, meaning that no other individuals or entities are parties to the transaction. Peer-to-peer transactions over the internet were impossible before the advent of the first cryptocurrency, and — as is explored throughout the paper — this seemingly straightforward innovation has widespread, profound, and exciting implications for policymaking and society. The ability to “cut out the middleman” in digital transactions creates a new paradigm for individuals, policymakers, and law enforcement alike because traditional digital financial transactions necessarily involve regulated intermediaries.

Some domestic and international regulators are concerned that individuals’ ability to engage in transactions without the use of middlemen creates unacceptable money laundering and terrorist financing (ML/TF) risks. Their concerns are understandable: illicit actors exploit the digital asset ecosystem, just as they exploit cash and the traditional financial system. The report addresses these concerns head-on, arguing that allowing individuals to transact on a peer-to-peer basis over the internet is a net positive for society and is therefore good policy. The paper presents four core arguments:

  1. Cryptocurrencies have long suffered from the (thankfully) fast-fading misperception that they are primarily used for illicit purposes. However, the best available evidence suggests that the percentage of activity (as well as absolute dollar amount) in the traditional financial system that is illicit is higher than the percentage of activity in the digital asset ecosystem that is illicit. Moreover, as evidenced by a string of recent forfeitures, law enforcement has become adept at identifying and seizing ill-gotten digital assets. Thus, additional restrictions on individuals’ ability to use self-hosted wallets would not only represent a disproportionate response to the risks posed by the illicit use of digital assets but would also undermine law enforcement’s ability to establish attribution in cases involving digital assets.
  2. As the economy and individuals’ lives have become increasingly digital-first, the use of cash transactions has declined precipitously, driving the vast majority of transactions to online platforms. Because traditional digital financial transactions necessarily involve an exploitable intermediary, they are by definition not private. In the same way, restrictions on self-hosted wallets would lay the foundation for total surveillance of citizens’ financial lives by eliminating a digital cash-like payment option, with potentially disastrous consequences for free societies.
  3. Additional restrictions on self-hosted wallets would eliminate the unique features of digital assets that make them a catalyst of expanding financial inclusivity. Because anyone with an internet connection can create and use self-hosted wallets to transact with others, they are the critical feature of digital assets that could make basic financial services available to the billions of people currently without access to these services. Critically, the digital divide must first be solved before this feature of self-hosted wallets can be fully exploited.
  4. Finally, additional restrictions on self-hosted wallets would indiscriminately apply payments regulation to a diverse and developing ecosystem with applications that extend far beyond the transmission of money. While payments using cryptocurrencies, one type of digital asset, are the use case of distributed ledgers that is currently the focus of regulators and policymakers, self-hosted wallets do not necessarily control digital assets that are used for payments. Just like a home safe, self-hosted wallets could be used to store cash-like assets in addition to other digital assets, including important documents and even immutable digital art. Importantly, with the digital asset and blockchain ecosystem still in its infancy, preemptively applying payments regulation to self-hosted wallets would inappropriately “pigeonhole” an innovative ecosystem that could bring revolutionary products and services to the market.

While readers may not agree with the conclusions drawn in the paper, restricting individuals’ ability to use self-hosted wallets, and by extension engage in digital peer-to-peer transactions, would have broad and long-lasting consequences for our society. With so much at stake, the Blockchain Association firmly believes that the debate surrounding peer-to-peer transactions using self-hosted wallets must be addressed by Congress. In other words, restricting peer-to-peer transactions using self-hosted wallets is a policy decision that has vast societal implications, and it should therefore be adjudicated by our elected representatives.

The unified voice of the blockchain industry. theblockchainassociation.org