Paradigm Responds to the CFPB’s Proposed “Larger Participants” Digital Wallet Rule

Paradigm Responds to the CFPB’s Proposed “Larger Participants” Digital Wallet Rule

Today, Paradigm filed a comment letter with the Consumer Financial Protection Bureau on their proposed “Larger Participants Rule,” which is intended to regulate digital wallets used in consumer payments. The CFPB ostensibly intended to establish greater oversight over a handful of large centralized digital payment service providers, such as Apple, PayPal/Venmo, and Block/CashApp,¹ but the scope of the rule would also capture Hosted and Unhosted Crypto Wallets, blockchain network financial and nonfinancial transactions, and all other manner of onchain activity – an onerous and overly-broad jurisdictional land grab.

In effect, the CFPB seems to have set out to hunt large game, and instead bagged all the animals in the jungle. It needs to release the “small animals” back into the wild.

The three most problematic areas within the Proposed Rule are:

1. Bitcoin and blockchain have been in active use since early 2009. The 2010 Dodd Frank Act, which authorized the CFPB, could have also granted the CFPB jurisdiction over this technology, and yet did not. As a result, the CFPB, while lacking Congressional authorization to regulate crypto, still seeks to do so under a provision designed to allow the agency to regulate student loan and automobile financing.² This is an extraordinary expansion of the agency’s interpretation of the Consumer Financial Protection Act.
2. The proposed definition of “wallet functionality” is broadly worded to capture crypto wallet software service providers that do not custody cryptoassets on behalf of users, or otherwise intermediate transactions. This would subject software developers to supervisory regulation on par with Big Tech payment processors, and would drive many of these developers offshore given the burden of compliance – limiting options for US consumers, and increasing risk of consumer harm.
3. The CFPB failed to adequately perform a fulsome cost-benefit analysis of the proposed rule, despite clear evidence that the lack of such analyses will be viewed dimly by federal courts. The CFPB admits (!) in the proposed rule that their cost-benefit analysis was of insufficient depth to adequately determine the impact the rule might have on wallet service providers or customers.³ At a high level, the CFPB fails to disambiguate Cash Wallets from Crypto Wallets in the course of its Digital Wallet rulemaking. “Cash Wallets,” like Venmo or CashApp, are similar to bank accounts in many ways, where the wallet provider typically custodies and maintains customer funds with the funds of other customers in an omnibus “for the benefit of”, or FBO, account. When the customer initiates a transfer of funds, the Cash Wallet provider must rely on the Automated Clearing House (ACH) or bank wire to move the funds.

Meanwhile, a “Crypto Wallet” is a blockchain network address to which cryptoassets may be allocated. A Crypto Wallet user may freely transfer those assets allocated to their network address to any other Crypto Wallet directly on the blockchain – without any intermediation by the Crypto Wallet provider, any bank, or payment system – by using their Wallet to signal the network their intent, desired onchain operation, or asset ownership update.

The difference is obvious and clear — while the former are more like “bank accounts on the Internet,” the latter are something more akin to technology data transfers. They are animals from different species that happen to look similar from a blurry distance.

Furthermore, unlike cash deposits in a bank account, cryptoassets represent all manner of goods and services. For example, one of the world’s largest ticket vendors offers support for concert tickets in cryptoasset format, and fine art auction houses across the globe regularly auction precious works of art in the cryptoasset medium by the likes of Damien Hirst, Refik Anadol, and Beeple.

In light of the issues raised by the potential application of this proposed rule, Paradigm strongly recommends that the CFPB consider expressly excluding Crypto Wallet providers – or, at a minimum, Unhosted Crypto Wallet providers, from the Proposed Rule at this time. The CFPB should also consider further revising the Proposed Rule to avoid potential administrative law pitfalls and adverse impacts upon the blockchain and crypto industry.

While Paradigm appreciates the CFPB’s engagement on these issues, we would also respectfully suggest the Bureau engage directly with Congress, which is currently evaluating comprehensive crypto market structure legislation. In such legislation, Congress might officially designate a role for the Bureau in regulating crypto alongside the other regulatory agencies. Given the CFPB’s history of narrowly dodging legal and political challenges to its existence, the CFPB helping Congress pass much-needed comprehensive and broadly bipartisan legislation on crypto market structure might be an opportunity for its operations to be further enshrined into our system of financial regulation.

Read the comment letter here.