BlogThe future of embedded wallets is regulated wallets

POSTED ON Mar 01, 2024

The future of embedded wallets is regulated wallets

Imagine a world where people are free to build, trade, and innovate without the constraints of traditional financial systems: no limited access to banking services, high transaction fees, slow cross-border payments, or centralized control. It’s a world where blockchain-based applications help businesses and users tap into new opportunities — from decentralized finance (DeFi), which offers more inclusive financial services, to smart contracts that automate and secure transactions, to non-fungible tokens (NFTs) that revolutionize the ownership and trading of digital goods and assets.

The truth is that this world is not some distant utopia. It's the web3 ecosystem that we're actively shaping today. In this rapidly evolving landscape, wallet-as-a-service providers are playing a critical role. And it makes sense, given that wallets are the connective tissue in an ecosystem built around storing and routing digital assets. 

But businesses have a choice when it comes to wallets, and that’s whether to build in a regulated or unregulated way. As we see more users and businesses adopt wallets controlled by developers and providers, it's crucial to examine the systemic risks that may arise without compliant and regulated wallets. So, let's dive deeper into what we see as the future of the wallet-as-a-service space, which is regulated wallets. If you’re looking for a provider or thinking of switching, this overviews how you can think about the benefits and risks associated with this choice. 

Advantages of regulated wallets

The web3 ecosystem holds the promise of transforming our digital lives, and to ensure its success, trust must be at its core. That means trust from a number of different audiences. If you’re a business or product leader, that means customers need to feel safe using your products, regulators and auditors need to ensure that they’re not permitting any illegal activity on your platform, investors and analysts need to trust they’re not supporting risky practices, and even your own product teams need to trust that what they’re building isn’t so risky that it could jeopardize their careers.

One crucial aspect of building this trust lies in the adoption of regulated wallets. These wallets provide the necessary safety and protection that users and businesses require to confidently embrace web3 technologies. But regulated wallets are about more than the logistics of compliance. They're about building that real trust across audiences, as well as safety and responsibility, that lets companies flourish. Businesses that choose a regulated provider ensure that they’re adhering to the right laws that keep their company and users secure — without having to invest the time and money in-house to keep up with the ever-changing landscape. 

What regulation includes

In terms of the actual requirements, regulated wallets align with money transmitter laws, ensuring that fraudulent activities are actively monitored, reported, and prevented. This extends to fulfilling crucial requirements under Anti-Money Laundering (AML), Counter-Terrorist Financing (CTF), and Bank Secrecy Act (BSA) regulations. Further, regulated wallet management providers undergo regular and random audits of their operations, security, financials, business continuity plans, and corporate controls. This ensures that every aspect of their service is held to the highest standard.

But what does all this mean for businesses and their users? As a company, by choosing a regulated platform, you can focus more on building innovative products that are protected, and as a user, you can feel more confident engaging with that business without worrying about the safety of your funds. Businesses get the security and peace of mind you'd expect from the best web2 experiences, with all the added advantages of web3 and its potential.

And to truly realize the countless opportunities of the web3 space, onboarding must be seamless. We often think of that in terms of user experience because it’s so critical, but it also applies to compliance and risk management. The integration of regulatory compliance with a user-friendly experience is a delicate balance to strike, but one that is vital to ensure the sustainable growth of this incredible industry.

Shaping the future of web3

Compliance isn’t just about mitigating risks. Adopting regulated wallets empowers businesses to focus on their core strength around innovation and offering the best product possible in their space. With the assurance of regulatory compliance, businesses can freely explore and leverage the exciting possibilities of web3 — without concerns about financial loss resulting from wallet providers exiting the market or facilitating illicit activities.

Moreover, it's imperative to recognize that safety and protection are not only important for one’s own web3 business, but also for fostering trust across the entire industry. Compliance with applicable laws, regardless of the underlying technology, is essential to establish trust with major web2 businesses and internet users. This entails recognizing the control that software and technology companies have over people and businesses' assets and taking the necessary steps to safeguard those assets.

The risks of unregulated wallets 

Unregulated wallets pose significant risks that may not only cripple a business, but also potentially destabilize the web3 ecosystem. The absence of regulatory oversight can invite fraudulent activities and financial crimes, which were major concerns in the traditional financial sector before regulations were put in place.

In the traditional financial landscape, regulatory measures are taken seriously. Banks and financial institutions operate under stringent requirements to maintain money transmitter licenses, conduct routine audits and comply with AML and CTF regulations. This regulatory framework ensures a level of security and trust, protecting consumers and businesses from the potential risks of financial crimes.

In the case of unregulated wallets, there is no government oversight to ensure compliance or any set of minimum standards to adhere to. This can lead to several potential hazards, from the loss of funds due to fraudulent transactions to being complicit in money laundering activities. In other words — even if a company doesn’t believe they have an obligation to monitor financial crimes, there is a repetitional risk of being an unwitting facilitator of money laundering. And no one wants to be known as the company that accidentally moved money for criminal organizations.

Lessons from traditional finance

Furthermore, the lack of obligation to hold a license, such as Money Transmitter License (MTL), which is required to facilitate exchange between digital and traditional currencies, means that unregulated wallet providers may operate without sufficient security measures or corporate governance controls, putting user assets at risk.

A notorious example of the risks posed by unregulated wallets was the infamous Mt. Gox incident. The lack of regulatory oversight allowed for the mismanagement and eventual loss of 740,000 Bitcoins, leading to the collapse of what was then the largest Bitcoin exchange.

In the context of web3, where transparency and trust are paramount, the potential risks associated with unregulated wallets can be catastrophic. As the web3 ecosystem continues to evolve, it's essential to apply the lessons learned from traditional finance and ensure that the same compliance and regulatory standards are upheld. This includes the implementation of necessary licensing, such as MTLs, to provide a safer, more secure environment for users and businesses alike.

Challenges and solutions

The journey towards regulated wallets is not without its challenges. Implementing regulatory requirements, especially in jurisdictions outside of the U.S. and Europe, can be complex and time-consuming. It requires a deep understanding of the different regulatory and compliance requirements that exist in these regions. That’s why partnering with companies with expertise to navigate them can be so beneficial. Some of the major challenges that regulated providers tackle include:

  • Obtaining MTLs or Money Service Business Licenses (MSB) for cryptocurrencies, semi-fungibles, and even non-fungible tokens (NFTs) in certain cases.
  • Adhering to security measures and corporate controls to ensure maximum protection of user funds.
  • Striking the right balance between seamless user experience and compliance requirements, such as fraud prevention through Know Your Customer (KYC), Anti-Money Laundering (AML), and sanctions screening.

These challenges highlight the need for wallet providers to work closely with regulators to outline clear controls and screening requirements that apply to the web3 space. Some solutions to address these challenges include:

  • Fostering open dialogue and collaboration between wallet providers and regulators to understand the unique nature of the technology and its compliance requirements.
  • Investing in robust fraud prevention mechanisms that incorporate KYC/AML/sanctions screening to ensure regulatory compliance.
  • Providing clear guidelines and documentation to users regarding the compliance measures in place and how their funds are protected.

By addressing these challenges and working hand in hand with regulators, wallet providers can navigate the complex landscape of regulatory requirements and ensure a secure and compliant environment for users in the web3 space.

Why Bastion is regulation-first

We take the benefits of compliance seriously and how that benefits our customers. That’s why we’re paving the way for compliance-first wallets — and we have since day one. As a leader in the wallet-as-a-service industry, we’re committed to integrating compliance into every aspect of our operations. We understand the transformative potential of regulated wallets, not just for our business, but for the entire web3 ecosystem.

We’re proud of that ongoing commitment to compliance. For instance, our recent acquisitions of MTLs in states like New Hampshire and Arkansas underscore our dedication to operating within the legal frameworks of every area we serve, on top of the MTLs we’ve already acquired. And we’ve invested in building a world-class, in-house compliance function. We’ve brought deep expertise in financial regulations and risk management onboard, so our team can design and implement comprehensive compliance programs that address risk from multiple angles, including AML, CTF, and fraud detection, while staying on top of an ever-changing landscape.

Compliance is the cornerstone of trust between us and our users. We believe that by setting high standards and meeting them, we are playing our part in creating a safer, more secure web3 ecosystem.

Putting it all together

As we stand on the brink of a new era in the digital world, the need for regulated wallets is more pressing than ever. These wallets hold the key to a secure, vibrant, and innovative web3 ecosystem — one where users and businesses can thrive without fear of financial loss, and safety and innovation go hand in hand.

Bastion views regulation not as an obstacle, but as a foundation for building a more secure web3. The future of wallet-as-a-service is here — and it's regulated. If you’re curious about how we can support your business, reach out to learn more about safer, more innovative web3 experiences.

We’re making the promise of web3 an uncomplicated reality for businesses and their customers.

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