Coinbase is now warning its European users about a proposal to add new know-your-customer (KYC) rules for cryptocurrency exchanges. The new law would require the cryptocurrency exchanges to perform a KYC check on any wallet that sends cryptocurrency to Coinbase before the funds can be deposited in the customer’s account. That’s bad for Coinbase because it would make it much harder to deposit cryptocurrency in the exchange, and it could even become impossible for many accounts.
The KYC rules apply to any wallet that sends money to your Coinbase account. This would include transfers from wallet holders who aren’t Coinbase customers and who want to protect their privacy, so it’s unlikely that they’d be willing to provide any documents to Coinbase. They might be willing to send cryptocurrency to Metamask or another decentralized wallet so you could transfer the funds in from a wallet you control, though. This would also be less convenient and might require paying additional gas fees.
I’ve deposited cryptocurrency into my Coinbase account from my Metamask wallet. Metamask wallets are decentralized and self-hosted. They’re not managed by any regulated financial institution and you don’t need to provide KYC documents to set one up. It may be possible to verify a Metamask wallet that you control anyway, though. You can import Metamask transactions into cryptocurrency tax preparation software if you hold the credentials for the wallet, and that may be enough to verify your identity as the wallet owner with a regulated exchange.
But the European Commission also wants Coinbase and other exchanges to verify other records for decentralized wallets. For example, anti-money-laundering (AML) requirements could force the exchange to check the transaction history of the wallet, and that process is challenging. For example, if you’ve used Metamask to make transactions that involve decentralized exchanges and wallets, which is likely if you’re using Metamask, it would be very hard for Coinbase to verify those transaction records and show that evidence to regulators. It would basically be the same situation that I’m in right now with tax preparation and it might be necessary to upload CSVs from multiple decentralized exchanges and wallets to deposit funds into Coinbase. It’s likely that Coinbase would have a partner like CoinTracker process these records.
The cryptocurrency exchange would still be responsible for verifying the CSVs and other transaction records itself. That’s more responsibility than a tax software app or tax preparer will accept. When you hire an accountant to prepare your taxes, they’ll tell you that you’re responsible for the accuracy of the documents that you give them. It’s not the tax preparer’s fault if documents are incorrect or fraudulent. But under the proposed regulations, the EC wants cryptocurrency exchanges to verify these documents themselves, and that’s a level of verification that might require an actual audit. It’s more likely that cryptocurrency exchanges would stop accepting incoming transfers, though. Audits are expensive and it’s unlikely that a customer would accept an audit just to deposit cryptocurrency into a centralized exchange.
It’s possible that if this proposal goes through, many users will simply stop depositing cryptocurrency into centralized exchanges. Many people are already doing this to avoid reporting taxable gains, which is probably one of the reasons why the European Commission wants to put the new KYC rules in place. But it’s likely that there will still be some way to convert cryptocurrency on a decentralized exchange into usable fiat currency, and if not there may still be ways to make purchases with that cryptocurrency. The centralized exchanges would probably lose many customers to decentralized exchanges.
The new rule change could also remove one of Coinbase’s main competitive advantages. This brokerage allows you to transfer cryptocurrency off-platform, which allows you to use it for many purposes. Many regulated brokerages store cryptocurrency themselves and don’t let you transfer it, so you can only speculate on the price of the cryptocurrency and can’t do anything else with it. You can’t use it for payments, you can’t use it to buy NFTs, you can just bet that its price will go up or down.
The new rules would also make cryptocurrency more regulated than other payment methods. For example, if you use cash to make a purchase at a store, you don’t have to tell the store where you acquired the cash, or provide the address and contact information for the person who gave you the cash. And you definitely wouldn’t have to give the store the full transaction history for the bank account you’re using.
It’s unclear if the new regulations will be approved. Coinbase is opposing them and many other cryptocurrency institutions oppose them as well. But if the European Commission does pass these laws it’s possible that other countries will implement similar laws. Right now, if you deposit $1000 in your account you have to provide KYC documents, for example. And that’s also true if you deposit EUR 1000 in Europe. That’s because of the FATF Travel Rule, which applies to cryptocurrency brokerages in every country, and this rule is why the EC is proposing new regulations.
The European Union will make its decision on March 31, 2022. That’s two days from now so it’s possible that the new rules will already be in place by the time many readers see this document. But I still felt that it was worthwhile to explain how the new rules work and why cryptocurrency exchanges are concerned about them. And, of course, these rules apply to Europe so readers in North America and other regions will have more time to consider their responses to similar proposals.