In June 2023, the Financial Services Agency of Japan (FSA) amended the Payment Services Act (PSA) to provide an updated regulatory framework for crypto assets and stablecoins. These regulations have clear implications for Crypto Asset Exchange Service Providers (CAESP) and the solutions they use to provide compliant services. 

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This article explores new “cold wallet” requirements that CAESPs should consider when evaluating compliant solutions. One such example of a compliant solution is the Blockdaemon Institutional Wallet.

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Stringent Rules Protect Asset Holders and Introduce Operational Constraints for CAESPs

As part of the PSA, the FSA introduced a number of rules to protect digital asset holders from potential leakages and bankruptcies of their Crypto Asset Exchange Service Providers (CAESPs). Some key rules include:

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1. A CAESP must manage users’ Crypto Assets and its own Crypto Assets in separate wallets.
2. A CAESP must manage at least 95% of users’ Crypto Assets in wallets that are not connected to the Internet (“cold wallets”).
3. A CAESP managing less than 5% of users’ Crypto Assets in “hot wallets” must manage the same type and amount of its own Crypto Assets in their own Redemption Guarantee Crypto Assets (RGCA) cold wallet to protect users against the risk of leakages.

These rules can seriously impact CAESPs, even those offering only custody services. For example, maintaining 95% or more of users' assets in cold wallets can make it challenging to provide various services without deviating from minimum thresholds.

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FSA Regulations Influence Custody Platform Solutions

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Blockdaemon works with leading CAESPs in Japan to provide custody solutions that minimize the need to transfer digital assets from cold wallets to hot wallets. One example is the Blockdaemon Institutional Wallet, which offers the ability to stake digital assets directly from cold wallet accounts to avoid the implications of using online hot wallets. 

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Most custodial solutions do not support staking directly from cold wallets, requiring digital assets to be transferred to hot wallets in order to stake. As described in the FSA rules, this can require the CAESP to acquire and hold an equivalent amount of the same asset type in a Redemption Guarantee Crypto Asset cold wallet. This creates a stranded capital burden for the CAESP,  increases risk by moving user assets online, and adds operational complexity and expense.

Blockdaemon has enabled CAESPs to stake digital assets like ETH directly from a cold or air-gapped configuration of Blockdaemon Institutional Wallet. Similarly, assets can be unstaked and returned to the original cold wallet  without ever bringing the digital assets or private keys online. This compliant approach eliminates the need for the CAESP to lock up their own digital assets in a Redemption Guarantee Crypto Asset cold wallet, maintains cold wallet security, and eliminates unnecessary transfer operations and expenses.

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Experience Cold Storage With Online Reporting and Operational Controls

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Blockdaemon Institutional Wallet offers many benefits to simplify regulatory compliance while maximizing security and operational efficiency. Institutional Wallet is available with both online and offline components, offering the best of both worlds. 

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The online wallet uses Blockdaemon’s patented Advanced MPC technology to generate, store, and use private keys as multiple distributed key shares hosted on premises or in secure cloud environments with the cloud service providers of your choice. Advanced policies can satisfy virtually any regulatory or governance models, and cryptographic enforcement of policies provides industry leading levels of security and control. Approvals defined by policies can be implemented using APIs or human approvers with mobile applications using biometric authentication. All actions are recorded in the audit log, providing easy reporting and auditing for internal and external purposes.

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Cold wallet applications are supported by a component that allows institutions to host private keys in offline, air-gapped servers for compliant cold storage and signing. The same online policy engine and mobile app approvals apply to the cold wallet accounts, giving CAESPs added control and flexibility, allowing key approvers to approve cold wallet transactions without being physically present. Cryptographically enforced online transaction intents are digitally signed, then exported to cold air-gapped wallet components. Here, pre-approved, policy enforced transactions are signed using cold, air-gapped private keys and subsequently broadcast to their respective blockchain networks via the online wallet counterpart.

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The innovative combination of online and offline operations improves control, operational efficiency, audit logging/tracking, and full regulatory compliance for cold storage services. For more information, please complete our contact form, and one of our in region representatives will provide additional details.

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