Sen. Warren’s Misguided War on Self-Custody of Digital Assets
New, Likely-Unconstitutional, Anti-Money Laundering Bill Proposed by Sen. Elizabeth Warren Fails to Address Money Laundering, and Undermines Consumer Protection in the Crypto Industry
If 2022 has taught us anything about consumer protection in the crypto industry, it is that digital asset investors should take extreme caution before turning over custody of their assets to “trusted third parties.” Firms like FTX, BlockFi, Celsius, and Voyager have a habit of going bust and losing customer deposits due to fraud or poor risk management. Instead, the safest way to hold digital bearer instruments like bitcoin is in “self-custody,” leveraging these assets’ remarkable native capabilities with the use of a security device like a “hardware wallet,” or a “collaborative custody model,” that permits users to control the private keys that secure their assets without counterparty risk. Yet, in the wake of the FTX/Alameda collapse, crypto-critic Senator Elizabeth Warren seems to have entirely missed this point. Instead, her proposed bill focuses on limiting Americans’ constitutional freedoms of speech, privacy, and association by proposing onerous regulatory burdens on the very types of US-based institutions best situated to prevent future consumer harms along the lines that we saw this year. Despite Senator Warren’s background in consumer protection and stated interest in preventing cybercrime and money laundering, her bill accomplishes neither. Instead, it is effectively a wholesale ban on the digital asset industry in the United States.
The provisions of the “Digital Asset Anti Money Laundering Act of 2022” call for the creation of a database of the digital asset holdings of ordinary Americans and severely hamper the ability of software companies to create secure, “non-custodial” crypto wallets that allow users to directly take control their own funds (one of the main value propositions of digital assets), rather than entrusting those funds to often-unreliable crypto exchanges and third-party custodians.  Let us be very clear: this bill, if enacted into law, would be illegal and extremely harmful to consumers and industry participants. It would do little if anything to prevent bad actors from leveraging crypto assets to launder the proceeds of criminal activity and would be a boon to future would-be embezzlers like Sam Bankman-Fried, who prey on the trust of ordinary crypto users.
Senator Warren’s bill contains five central proposals, many of which are dangerous, unconstitutional, or otherwise misguided. The most absurd of which can be found right at the start: The bill seeks to designate purveyors of “unhosted wallets” (better known as “self-hosted” wallets) as Money Service Businesses or MSBs, subjecting them to burdensome, expensive, and unnecessary state-by-state licensing and reporting requirements that are impossible for software providers to comply with in many cases. The result would be to impose an Orwellian regime of digital surveillance over ordinary Americans’ financial lives and (what we suspect is the true motive behind this proposed legislation) to severely impede the viability of the digital asset industry within the United States.
MSBs are defined as “any person or entity doing business as (1) a currency dealer or exchanger check casher, (2) an issuer of traveler’s checks, money orders or stored value, (3) a seller or redeemer of traveler’s checks, money orders or stored value, or (4) a money transmitter.” The most common type of MSB is a “money transmitter” which is defined as “[a]ny person, whether or not licensed or required to be licensed, who engages as a business in accepting currency - or funds denominated in currency - and transmits the currency or funds, or the value of the currency or funds, by any means through a financial agency or institution, a Federal Reserve Bank or another facility of one or more Federal Reserve Banks, the Board of Governors of the Federal Reserve System, or both, or an electronic funds transfer network” or “any other person engaged as a business in the transfer of funds.” MSBs must register with the Financial Crimes Enforcement Network (FinCEN), register for a series of expensive (generally $500,000 to $2,000,000 in legal fees) and time-consuming state-by-state licensing applications that create a high barrier of entry for American crypto startups, as well as comply with a host of anti-money laundering (AML) and know-your-customer (KYC) regulations that in many cases are literally impossible for self-custody wallet providers to comply with. Importantly failure to comply with these regulations is both a civil and criminal offense, carrying a penalty of up to five years in prison.
Until now, FinCEN has specifically excluded self-custody wallets from the definition of an MSB—which makes sense. MSB designation has been limited to “hosted wallets,” where the “keys” to the digital assets in question are held by (and thus the assets are controlled by) a custodian on behalf of the beneficial owner. In the case of such a “hosted” wallet, the third-party custodian has complete, independent control over the movement of beneficiaries’ digital assets, who themselves are treated as unsecured creditors. This is the arrangement that depositors have with most cryptocurrency exchanges and yield-generating accounts like those previously maintained by BlockFi, Voyager, and Celsius, and the reason that these customers are unable to recover funds in the wake of those institutions’ insolvency.
In contrast, a self-custody wallet (often ominously called an “unhosted wallet”) is simply a piece of software that allows its users to secure digital assets using a cryptographic password called a “private key”—this is called “self-custody.” In essence, someone practicing self-custody is holding their digital assets in the same way that they would hold cash in a physical wallet or precious metals in a home safe, rather than trusting a third-party custodian like a bank or a brokerage to custody their money or gold on their behalf. Much like their analog counterparts, developers of self-custody crypto wallets lack any kind of meaningful access to their users’ funds, and would not be able to embezzle or rehypothecate those funds or lose funds to a hack, as is all too common in the digital asset sector. Moreover unlike bona fide financial institutions that custody clients’ funds on their behalf, purveyors of self-custody wallets to not have any insight into the balance of digital assets in their customers’ wallets or who their customers’ financial counterparties are. Therefore treating software companies that create self-custody crypto wallets as MSBs is just as absurd as requiring companies that sell physical wallets or at-home safes to report to the government the amount of cash or precious metals held in their customers’ wallets and safes, respectively, and to report where and to whom their customers’ give their cash or precious metals. In the digital, as in the analog instance, such regulations are nonsensical, impossible to comply with, and therefore simply amount to a ban on the self-custody of financial assets.
Ironically, even partial implementation of this proposed regulation of self-custody wallet providers as MSBs is dangerous to consumers, anti-progressive, and likely unconstitutional—all of which seem to run counter to the rest of Senators Warren’s political views outside of crypto:
First, as we have seen demonstrated time and time again from government data breaches, such as the infamous OPM records hack of 2013 and the more recent large-scale SolarWinds hack by Russia in 2020, government databases are an extremely attractive target for hackers and malicious foreign actors. Keeping a centralized database of the amount of wealth, held in the form of digital bearer instruments that can be stolen from individuals’ homes through burglary, kidnapping, or other threats of violence needlessly puts innocent Americans’ safety at risk.
Second, throttling the ability of software providers to offer free and open-source self-custody wallets runs counter to Senator Warren’s own purported progressive values. “Self-sovereign” use of digital assets like bitcoin empowers unbanked or under-banked individuals to take control of their own savings and participate in the global economy without the need for intermediaries or gatekeepers. This is crucial for the billions living under autocratic regimes or in unstable economies as it allows them to hold assets and transact. Here at home, according to a report from the Federal Reserve, “those using cryptocurrencies for purchases rather than as investments frequently lacked traditional bank and credit card accounts” and “[n]early 6 in 10 adults who used cryptocurrencies for transactions had an income of less than $50,000.” Moreover, cryptocurrencies play an important role in the remittances sent by many immigrants back to their home countries and reduce the dependence on money transfer companies such as Western Union and MoneyGram.
Finally, the imposition of this type of “prior restraint” on self-custody wallet developers is abhorrent to the values enshrined in the First Amendment of the United States Constitution—which as a former law professor, Senator Warren should be well aware of. This bill would require any would-be wallet developer to register with the government as an MSB before publishing code that would allow users to take custody of their own digital assets (even if that code is made freely available as an open-source project), running counter to decades of free speech jurisprudence in the federal courts. Moreover, by applying the reporting requirements of the Bank Secrecy Act to self-custody wallets (as well as banning any type of anonymizing software for digital asset transfers), Senator Warren’s bill would eliminate the ability of crypto users to make confidential donations to political or charitable causes that are crucial to the freedom of assembly enshrined in the First Amendment. And by deputizing software providers, Bitcoin miners, node runners, and other industry participants to report to the government on the minute details of the financial activities of their customers in the absence of any evidence of wrongdoing, this bill may also run afoul of the Fourth Amendment’s protections against unreasonable searches and seizures.
To make matters worse, Senator Warren’s bill would do little or nothing to combat the bona fide money laundering that happens through the use of digital assets or to prevent the type of consumer harm that took place with the FTX collapse. Instead, Senator Warren appears to be opportunistically exploiting these problems to promote her uncharacteristically pro-Wall St digital asset agenda. Most wrongdoers, such as hackers, drug dealers, and human traffickers, who use cryptocurrencies to launder the proceeds of their criminal activities, do so either through entirely unregulated offshore decentralized “tumblers,” that would not fall within the jurisdiction of Senator Warren’s proposed bill, or through the use of borrowed, stolen, or faked identification documents that would appear fully compliant with, and thus undetectable by, the KYC/AML requirements that Senator Warren is trying to impose. By and large, the only digital asset users that would be affected by this bill would be law-abiding citizens that use digital assets to secure wealth or to transact on a day-to-day basis.
Furthermore, this crackdown on self-custody wallet providers would drive American consumers directly into the hands of the type of centralized custodians that led to the most catastrophic losses of the past year. Senator Warren’s bill is exclusively focused on financial surveillance to the exclusion of any meaningful consumer protection that would prevent the type of corporate abuse that took place at FTX. If Senator Warren was truly concerned with consumer protection, she could propose legislation that clarified the legal status of various types of digital assets in the United States and pave the way for responsible infrastructure to protect the capital markets for digital assets within our shores. 
The proposed "Digital Asset Anti Money Laundering Act of 2022" by Senator Elizabeth Warren is misguided and dangerous. The bill's focus on designating purveyors of self-custody wallets as MSBs would threaten the safety of law-abiding citizens, impose unnecessary, unhelpful, and unconstitutional restrictions on Americans’ financial lives, and severely impede the viability of the digital asset industry in the United States. Furthermore, the bill does nothing to prevent bad actors from using crypto assets to launder money, and would actually be a boon to future embezzlers like Sam Bankman-Fried. In short, this bill should be soundly rejected by the United States Senate and vigorously contested in court in the event that it is passed.
 See https://www.warren.senate.gov/imo/media/doc/DAAML%20Act%20of%202022.pdf.
 Id. at 2-3.
 31 CFR § 1010.100(ff)
 31 CFR 103.11(uu)(5)
 18 U.S. Code § 1960 (a)
 See www.financialinclusion.tech; https://www.thedialogue.org/analysis/will-cryptoassets-disrupt-remittances-in-latin-america/ (“Remittances using cryptocurrencies grew 900 percent worldwide last year, with Venezuela, Argentina, Brazil, Mexico and El Salvador showing high levels of growth in crypto money transfers.”)