Treasury Withdraws Controversial Unhosted Wallet Proposal, but IRS Draft Form Reignites Debate

TLDR:

• Treasury withdraws 2020 FinCEN proposal on unhosted wallet KYC requirements
• Proposal faced strong industry opposition due to technical infeasibility
• Travel Rule proposal from 2020 still under consideration
• IRS draft Form 1099-DA controversially includes unhosted wallets as brokers
• Draft form not final; 60-day comment period open for feedback

The U.S. Treasury Department has officially withdrawn a controversial 2020 proposal that sought to impose know-your-customer (KYC) requirements on unhosted cryptocurrency wallets.

The proposal, introduced by the Financial Crimes Enforcement Network (FinCEN) during the final days of the Trump administration, faced significant backlash from the crypto industry and lawmakers alike.

The original proposal aimed to require banks and money service businesses to collect and report identity information for transactions involving unhosted wallets.

Critics argued that the requirements were technically impossible to implement for most wallets, as they are not companies or entities that typically collect personal data.

The withdrawal of the proposal, announced in the Federal Register on August 19, 2024, marks the end of a contentious debate that lasted nearly four years.

Michael Mosier, former acting director of FinCEN, praised the decision, stating that it demonstrates a willingness by public servants to engage collaboratively with the industry on innovation and risk management.

While the unhosted wallet proposal has been shelved, another related proposal from 2020 remains under consideration.

This proposal seeks to implement the Travel Rule, a Financial Action Task Force (FATF) regime designed to combat money laundering in cryptocurrency transactions. The Travel Rule would require financial institutions to report personal information for senders and receivers of transactions over a certain limit.

The Internal Revenue Service (IRS) has released a draft version of Form 1099-DA, which has sparked new controversy within the crypto community. The draft form, published on April 19, 2024, includes unhosted wallets in its definition of brokers for tax reporting purposes.

This inclusion has drawn criticism from industry experts who argue that unhosted wallet providers lack the necessary information about transactions and parties involved to comply with such requirements.

Ji Kim, Chief Legal and Policy officer at the Crypto Council for Innovation, called the approach “unfortunate,” highlighting the fundamental misunderstanding of how unhosted wallets operate.

The IRS released a draft Form 1099-DA for reporting “Digital Asset Proceeds from Broker Transactions”: https://t.co/NSSu8prl4X

As a refresher, this is the form that “brokers” will start using in 2025 to report digital asset transactions to customers. This is a draft form…

— Ji Kim (@_jikim) April 19, 2024

The draft form also requires brokers to provide certain on-chain data, including transaction IDs and wallet addresses related to each sale. This requirement has raised concerns about privacy and security among some experts. However, others have noted that the form includes exceptions for cases where such information is not applicable.

It’s important to note that the IRS draft form has not been finalized, and a 60-day comment period is currently open for industry feedback. The IRS has explicitly stated that brokers should not use the draft form for current tax reporting.