Digital Wallets and Selected Policy Issues

Digital Wallets and Selected Policy Issues

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April 18, 2022
Digital Wallets and Selected Policy Issues
Digital Wallet Landscape
to a specific merchant. For example, someone might use a
A digital wallet is a software application that stores
wallet to make payments at a grocery store, purchase goods
payment or account details to facilitate traditional payments
online, or pay rent. General purpose mobile wallets include
that use bank and credit card details and/or cryptocurrency
apps tied to a smartphone and those that can be used on any
transactions. In addition, wallets facilitate peer-to-peer
device. Often the companies that provide general purpose
transfers, which have grown rapidly in recent years (Figure
wallets are regulated as money transmitters, a state-licensed
1). This In Focus discusses three types of digital wallets and
financial business that moves money between customers.
addresses selected policy issues.
Cryptocurrency wallets can be divided into three types.
Functionality and Scope of Use
Custodial wallets are “hosted” or maintained by third-party
Digital wallets are generally used for (1) payments to
institutions (such as a crypto exchange). They are funded by
merchants through the use of near-field communication or
bank accounts, and most can be used to buy, sell, or trade
QR codes for in-person purchases; (2) peer-to-peer transfers
certain digital assets. Platforms that host custodial wallets
of funds through an app, via text message, or QR codes; (3)
execute digital asset transactions on the account holder’s
storing value from a linked bank account or debit card on
behalf and log them on the custodian’s books (or “off-
an app-based account; or (4) storing, providing access to,
chain”) rather than on the distributed ledger blockchain of
and transacting in cryptocurrency. (For more on
the coin. Non-custodial wallets are not hosted by third-party
cryptocurrency, see CRS Report R45427, Cryptocurrency:
institutions. They maintain the keys necessary to access and
The Economics of Money and Selected Policy Issues.)
sign the assets for transmission to blockchains and represent
the asset’s location on the network. Loss of private keys
Digital wallets generally require the use of internet-
renders cryptocurrency irretrievable. A non-custodial wallet
connected hardware, such as a smartphone. Some, including
user can transact in crypto without relying on a custodian.
Apple Pay and Google Pay, may work only with certain
Cold-storage wallets are pieces of hardware that allow end
devices and associated operating systems. Others, such as
users to store cryptocurrencies offline, a practice that
the PayPal or Cash apps, can be downloaded and accessed
shields them from hacking. Cold-storage wallets can be
from a range of devices, irrespective of operating system.
connected to the internet to perform transactions.
For conceptual simplicity, it can be helpful to think of
digital wallets as belonging to one of three groups: retailer-
Policy Considerations for Digital Wallets
specific, general purpose, or cryptocurrency.
Wallets are not themselves accounts or payments but a
vehicle for accessing accounts or making payments. Many
Figure 1. Peer-to-Peer Transaction Value
policy issues that relate to accounts and payments, but not
wallets, are often conflated with digital wallet issues. Policy
issues highlighted below are specific to wallets.
Data Privacy and Security
Companies offering digital wallets and payments
companies generate, and may collect, information about
users as part of their business models, raising concerns
about privacy and data security. These companies are
subject to certain provisions of the Gramm-Leach-Bliley
Act (P.L. 106-102) that protect users’ nonpublic personal
information (NPI). In particular, the act requires the
companies to provide privacy notices to consumers about

how they use their data and to safeguard the confidentiality
Source: eMarketer, https://www.emarketer.com/content/zelle-
of NPI from unauthorized access, but they can typically
records-explosive-q2-growth-faces ... rivals.
share information with affiliates and may share information
with nonaffiliates unless users opt out.
Retailer-specific mobile wallets are offered by a retailer for
use to purchase its goods and services. They allow
This policy issue may be addressed through a potential
individuals to store payment card information, upload funds
proposed rulemaking for Section 1033 of the Dodd-Frank
to digital or registered gift cards, or prefund a balance on an
Act (P.L. 111-203). Section 1033 requires any company or
app for future transactions.
individual offering financial services to provide information
it has collected in offering or providing the service to any
General purpose mobile wallets provide much of the same
consumer that requests it. The law, which has not yet been
functionality as retail-specific wallets do but are not limited
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Digital Wallets and Selected Policy Issues
implemented through rulemaking, would provide
structure as introducing a principal-agent conflict. Non-
consumers with greater access to their financial data and
segregated accounts could also make it harder for investors
with it the right to take that data and their business
to recover assets if an exchange failed or was hacked.
elsewhere. Whether this requirement would apply to a
digital wallet company remains to be seen.
Systemic Risk and Market Power
Mobile wallets. Multilateral standard-setting bodies such as
In October 2021, the Consumer Financial Protection Bureau
the Bank for International Settlements have suggested that
(CFPB) ordered Amazon, Apple, Facebook, Google,
central banks may “need to introduce specific safeguards to
PayPal, and Square to submit information about their
guarantee sufficient operational resilience” for companies
payment products to monitor risks to the public and
“offering systemically important payment services to a
determine whether the operators will “engage in invasive
significant section of the population.” While this risk is
financial surveillance and combine the data they collect on
arguably not material in the United States, “Big Tech”
consumers with their geolocation and browsing data” and
companies offering these services pose a risk because of
“use this data to deepen behavioral advertising, engage in
their size and ability to quickly capture market share. Even
price discrimination, or sell to third parties.” Some
if these companies are not systemically important, wallets
observers have speculated that a CFPB rulemaking may
may provide them with an entree to offer consumers an
follow.
expanding suite of financial services and products. In
addition, commercial (i.e., non-financial) enterprises’ entry
Consumer Protection and Investor Protection
into payments, which has traditionally been the realm of
Mobile wallets. A consumer using a debit, credit, or
banking, represents a joining of industries typically kept
prepaid card stored on a mobile wallet is protected by the
separate as a matter of long-standing U.S. policy.
Electronic Funds Transfers Act (P.L. 95-630) and the Truth
in Lending Act (P.L. 90-321), implemented through CFPB
The Dodd-Frank Act allows financial institutions and
Regulations E and Z, respectively. Among other things,
payment systems to be designated as systemically important
these regulations establish procedures for resolving errors
and subject to heightened prudential standards. It is unclear
with unauthorized transactions. Further, consumer credit
if this authority could be applied to wallet providers.
products offered by wallet companies are regulated as
consumer credit whether or not the funds or account
Crypto wallets. The President’s Working Group’s (PWG)
information are stored in a digital wallet. Recent
report on stablecoins addresses, among other things,
rulemakings by the CFPB, such as the 2019 prepaid card
systemic risk as it relates to digital asset wallets and
rule, effectively extend some of these protections to certain
stablecoins. The PWG report notes that stablecoins’
digital wallet transactions.
potential to scale rapidly and inherent run risk could pose
systemic risk if one member in the stablecoin arrangement
Funds stored on a wallet are not deposits and are generally
(e.g., a crypto custodian) were to fail or experience distress.
not eligible for deposit insurance. However, some wallets
provide “pass-through insurance” if a consumer transfers
In addition, the PWG report notes that a company both
money from a direct deposit to a wallet account. In this
hosting a custodial wallet and issuing a stablecoin could
scenario, the wallet provider would act as a custodial agent
result in an excessive concentration of economic power in
and deposit the money into an FDIC-insured bank account.
the economy and decrease competition. Coinbase—a
Where insurance is not offered, policymakers may wish to
partner in the issuance of a prominent stablecoin and a large
consider whether wallet users are under the false impression
custodial-wallet provider—exemplifies this concern.
that their wallet balances are insured and whether uninsured
Among the PWG’s recommendations for regulating
balances pose systemic risk.
stablecoins is that custodial wallet holders be subject to
“appropriate federal oversight.”
Crypto wallets. One consideration in the ongoing policy
debate is if and how digital asset wallets and the companies
Financial Inclusion
that provide them should be regulated and whether the
Wallets may increase user convenience, but inclusion is an
payments regulatory framework should apply to them.
issue of access to accounts, not wallets. Research shows
Cryptocurrency transactions are not subject to Regulation E
digital payments create alternatives to traditional bank
primarily because these are not bank products and also
products that can promote financial inclusion among the
because cryptocurrencies are not typically used for
unbanked, but it typically applies to countries where bank
consumer payments. As the discussion around whether and
use was not prevalent and alternative accounts or value
to what extent banks may be allowed to participate in
storage grew in the absence of bank accounts. However, in
cryptocurrency evolves, certain Regulation E protections
the United States, where the majority of consumers have
could be extended to any bank-based cryptocurrency
access to bank accounts and other financial services, digital
products that are stored in digital wallets or even potentially
wallets may serve only as an ancillary or complementary
other cryptocurrencies stored in a bank-issued digital wallet
good. Furthermore, they are typically used on smartphones
if such a scenario were to emerge.
that the unbanked may not possess.
Digital assets in custodial wallets reside in non-segregated
Paul Tierno, Analyst in Financial Economics
“omnibus accounts” of the digital exchange, which may
Andrew P. Scott, Analyst in Financial Economics
comingle user and platform assets, unlike a traditional
investment account. Market observers have criticized this
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Digital Wallets and Selected Policy Issues

IF12079

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