As the use of cryptocurrencies is becoming increasingly mainstream, the importance of understanding how to securely manage cryptocurrencies and other virtual assets cannot be overstated. A key consideration to keep in mind while managing virtual assets is selecting the appropriate type of virtual asset wallet. A virtual asset wallet is generally understood as a software or application that stores the public and private keys required for a user to buy, trade and evidence ownership of their virtual assets. There are two broad types of such wallets, which are:

a) Custodial wallets.

b) Non-custodial wallets.

While the security offered by the type of the wallet chosen is primarily dependent on the protections offered by the software behind that wallet, it is also important to consider the rules and regulations applicable to that particular wallet to ensure that the service provider is conducting its activities in a legally sound manner.

This article explores what non-custodial wallets are, their features, and the rules and regulations applicable to service providers looking to offer non-custodial services in mainland UAE. By its nature, this article does not delve into the rules and regulations applicable to entities incorporated in the Emirate of Dubai and in financial free zones governed by the Federal Financial Free Zones Law, such as Abu Dhabi Global Market (ADGM) and the Dubai International Financial Centre (DIFC), as they have different regulatory regimes applicable to the operation and licensing of non-custodial wallets.

What is a Non-Custodial Wallet?

A non-custodial wallet, also known as a self-custodial wallet, is a wallet in which the users are responsible for storing and managing their private keys. Private keys are cryptographic keys that are essential for accessing and managing the virtual assets stored in the wallet. Instead of third parties like crypto exchanges having custodial access, each user has full control over their virtual assets. This gives users full access and responsibility for securing their virtual assets and ensures that they are the sole owners of their virtual assets by virtue of their control of their private keys.

Non-custodial wallets are typically used to store, manage, transfer virtual assets through its interaction with decentralised finance applications and other blockchain ecosystems. In general, there are three types of non-custodial wallets, which are:

1. Software Wallets

These are software applications that users can install on their electronic devices. Examples include MetaMask, Trust Wallet, and Exodus. Due to their ease of integration, they are convenient and suitable for everyday interactions with decentralized applications.

2. Hardware Wallets

Hardware wallets are devices that are used to keep private keys safe offline. Common choices are Ledger, Nano X, and Trezor. They are secure and useful for storing virtual assets for an extended period of time and for managing significant numbers of virtual assets.

3. Paper Wallets

A paper wallet is a printout or a piece of paper containing a user’s private and public keys. While they are safe from online hackers due to their offline status, paper wallets could be subject to physical damage and loss.

Key Features of Non-Custodial Wallets

• Total ownership and control of private keys: Users have complete ownership of their virtual assets by virtue of their control over their private keys.
• No third-party access: Since the wallet provider does not store an individual’s private keys, they cannot access any funds or control any transactions.
• Increased security and privacy: As there is no reliance on a third party, there is less risk of hacks or breaches from a centralized provider.
• Sole responsibility: Users have to assume sole responsibility for protecting their private keys. If their private keys are misplaced or stolen, there is no backup in place to recover their virtual assets.

Licensing Considerations

Entities that are incorporated in mainland UAE (excluding those incorporated in the Emirate of Dubai) and looking to practise any activities related to virtual assets would typically need to obtain a license to validly practise such activity from the Securities and Commodities Authority (“SCA”) and/or the Central Bank of the UAE (“CBUAE”) depending on their intended use. If they are being used for investment purposes, they will be regulated by SCA. However, if they are used for payment purposes, such as stored value facilities, those types of virtual assets will be subject to the jurisdiction of the CBUAE.

Under the applicable SCA rules, regulations and guidelines, which includes the Securities and Commodities Authority Guidelines on the Regulation of Virtual Assets and Virtual Assets Services Providers (“SCA Guidelines”), entities that are providing non-custodial wallet services would generally not be required to apply for a license from SCA, as the service provider is merely providing the technology behind the cryptocurrency wallet, and it is the wallet user who has full control and responsibility over their virtual assets – not the service provider. Hence, the operation of non-custodial wallets are typically not directly regulated by SCA, as they are considered tools or software that allow users to manage their own private keys without the need for third-party intervention.

Similarly, given that non-custodial wallet service providers only provide the means for users to control and manage their virtual assets, and do not hold, control, manage or transfer virtual assets themselves, they would also normally not be directly regulated by the CBUAE.

AML and KYC Considerations

As part of the UAE’s strong efforts to fight financial crime and money laundering, the CBUAE has issued a number of federal laws applicable to all entities incorporated in the UAE.

These federal anti-money laundering and countering financial terrorism laws (“Federal AML Laws”) apply to all institutions practicing “financial activities” and “designated non-financial businesses and professions” (“DNFBPS”), including entities incorporated in financial free-zones and across all Emirates of the UAE. However, non-custodial wallet services are normally not considered as a financial activity or a DNFBPS, and entities offering such services would generally not need to abide by the provisions of the Federal AML Laws. With this being said, it is recommended that service providers adopt best anti-money laundering practices and procedures to help the UAE in its fight against financial crime.

“In summary, entities incorporated in mainland UAE that are looking to offer non-custodial wallets would generally not need to obtain a license from SCA or CBUAE to practise such activity in the UAE and would not need to abide by the Federal AML Laws.”

We will explore the non-custodial wallets regime in the Emirate of Dubai in the next part of our series on the Legal Regime on Virtual Assets and Cryptocurrencies in the UAE.

If you require any further specialised advice on the licensing and regulation of services related to non-custodial wallets or virtual assets in general, please contact any member of our specialised team to discuss.

Prepared by:

Malack Elmasry – Partner
Maryam Quadri – Associate
Anirudh Sundarrajan – Associate