As the U.S., U.K., Europe and countries around the world stiffen sanctions in the hope of forcing Russia to retreat from its invasion of Ukraine, some of the sanctioned entities are likely to try to use bitcoin and other cryptocurrencies to evade the restrictions, if they haven’t already.
Can they successfully get around the regulatory roadblocks?
Among the people worried about the risks are U.S. Sens. Elizabeth Warren, D-Mass., Mark Warner, D-Va., Sherrod Brown, D-Ohio, and Jack Reed , D-R.I., who sent a letter to Treasury Secretary Janet Yellen on Wednesday asking about the potential use of cryptocurrency to evade sanctions.
In the letter, the senators asked to know more about “the Treasury Department’s progress in monitoring and enforcing sanctions compliance by the cryptocurrency industry and to express our concern that criminals, rogue states, and other actors may use digital assets and alternative payment platforms as a new means to hide cross-border transactions for nefarious purposes.”
The Treasury’s Office of Foreign Assets Control asserted in October that all actors in the cryptocurrency space are “responsible for ensuring that they do not engage, directly or indirectly, in transactions prohibited by OFAC sanctions.”
But the senators called for strong enforcement of sanctions compliance in the cryptocurrency industry, “given that digital assets, which allow entities to bypass the traditional financial system, may increasingly be used as a tool for sanctions evasion.”
Though many cryptocurrencies were developed in a libertarian, anti-government spirit, most exchanges are subject to regulations that require them to know and screen their customers and not serve those on sanctions lists (just as other financial institutions are subject to similar rules). And technology that attempts to identify who is doing what on cryptocurrency blockchains improves all the time.
Companies like Chainalysis, CipherTrace, Elliptic and Elementus, among others, are analyzing cryptocurrency transaction activity and can link it to the people and entities controlling those crypto-asset wallet addresses.
There are also other mechanisms sanctioned Russian entities can use.
“The fixation in certain circles on Russia using crypto to bypass sanctions is misplaced,” said Sultan Meghji, who until last month was chief innovation officer at the Federal Deposit Insurance Corp. “It's structurally impossible at scale, and certainly not the easiest mechanism. Myriads of other long existing avenues are easily available.” For instance, Russia uses payment networks shared by China and other countries that don’t observe U.S. sanctions.
How likely are Russians to use cryptocurrency?
“As sanctions begin to have their effects, Russia and other sanctioned entities are going to be looking for ways that they can access the U.S. dollar,” said Caroline Brown, a partner at Crowell & Moring in Washington. “They're going to have to find ways to circumvent existing sanctions. Because of the so-called anonymity that some cryptocurrency transactions offer, this could be an attractive way to work around those things.”
Criminal groups in Russia already use cryptocurrency to cover their tracks, noted Max Galka, founder and CEO of Elementus.
“Right now, a little bit less than 1% of bitcoin transactions are associated with some sort of illicit or at least potentially suspicious activity,” Galka said. “And of that 1%, about half of it happens among entities based in Russia. So there is already a lot happening within Russia in the domain of crime.” Ransomware, for instance, is predominantly operated by Russian crime groups, he said. They tend to ask for ransom in bitcoin for the purpose of getting around anti-money- laundering controls.
“So even before looking at sanctions, there's already a lot of actors operating in Russia that are using bitcoin to try to avoid detection,” Galka said.
In other heavily sanctioned countries like Iran and Venezuela, cryptocurrency is used to get around restrictions.
“Both governments have explicitly encouraged the use of cryptocurrency for the purpose of circumventing sanctions,” Galka said. “The Venezuela government itself operates a variety of crypto services right on the government web domain and it has relationships with a number of exchanges operating in Venezuela.” In Iran, too, there are several services explicitly designed to help people evade sanctions using cryptocurrency and the government, he said. Both countries have also taken steps to set up new cryptocurrency mining operations.
Could crypto-using sanctions evaders be detected?
“Cryptocurrency transactions occur outside the traditional banking network,” noted Henry Balani, global head of industry and regulatory affairs at Encompass, a regtech that automates KYC due diligence. “The decentralized nature of crypto means that, in theory, entities that use crypto could potentially evade sanctions and not get caught.”
But there are complications.
“In order to use crypto to evade sanctions, both the recipient and beneficiary need to agree to use crypto to settle the transaction and maintain it in crypto,” Balani said. “While there are more businesses willing to accept crypto, for large-value transactions like energy contracts and industrial equipment purchases, most companies prefer fiat over crypto.”
The challenge then becomes in converting the crypto to fiat currencies like U.S. dollars and British pounds.
“Crypto exchanges are similarly regulated like traditional financial institutions where they must perform [know-your-customer] due diligence on their customers,” Balani said. “If a Russian sanctioned entity attempts to either buy or sell crypto in exchange for fiat, their assets will be frozen, or the crypto exchange runs the risk of penalties.”
Current sanctions target large Russian banks, state-owned enterprises and oligarchs that typically deal with high value transactions, often in the millions of dollars, Balani noted. It can be hard to conduct such large transactions undetected.
The “so-called anonymity” of cryptocurrency Brown noted has two sides to it: On one hand, contact information is not stored on public blockchains, so transactions are anonymous. But those transactions are visible for all to see and monitor. Technology developed by companies like Chainalysis, CipherTrace, Elliptic and Elementus is used by law enforcement, government agencies, banks and other companies to link the crypto asset addresses used in transactions with the people and organizations behind them.
Whether or not Russian entities could be caught using cryptocurrency to skirt sanctions depends on the jurisdictions where the cryptocurrency companies they use are operating, Brown said.
“Under U.S. anti-money-laundering and sanctions laws, you have to know the identity of your customer,” Brown said. Cryptocurrency exchanges that are compliant screen for sanctioned entities and do whatever the sanctions require, such as block, freeze or wind down accounts.
“Law enforcement agencies will be working to ensure companies are complying with AML laws,” Brown added.
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The technology provided by Chainalysis, CipherTrace, Elliptic, Elementus and others identifies legitimate, regulated cryptocurrency exchanges like Coinbase. And it identifies entities that traditional financial institutions want to avoid, such as ransomware users, human traffickers, Russian crime groups, darknet markets and sanctioned companies and people.
Such software can also identify suspect services like peer-to-peer exchanges that match buyers and sellers and have few know-your-customer procedures in place, so people can sign up with fake email addresses. It identifies “mixers” or “tumblers” that obfuscate where funds are coming from. All of these become red flags for the banks and government agencies that use the software. Chainalysis, for instance, has been used by Barclays for four years and BNY Mellon announced yesterday it’s working with the company.
However, not all cryptocurrency exchanges, law enforcement agencies, and banks use such technology, and not all are scrupulous about know-your-customer and sanctions screening compliance.
As Ryan Gurule, policy director at the Financial Accountability and Corporate Transparency Coalition, points out, there are already gaps in the way anti-money-laundering and counterterrorism compliance is handled in the U.S. The Coalition is an alliance of more than 100 state, national, and international organizations working to combat the harmful impacts of corrupt financial practices. For instance, the group aims to end the use of anonymous shell companies as vehicles for illicit activity and to strengthen and enforce anti-money- laundering laws.
“The [U.S. Treasury’s] Financial Crimes Enforcement Network, the IRS and the FBI to some extent have clearly identified that there are tax evasion and money laundering risks associated with cryptocurrency,” Gurule said. “It's impressive that they've done so given, especially in the IRS and Fincen’s case, how underfunded they've been in recent years.”
One way to ensure cryptocurrency exchanges comply with sanctions is to properly fund these agencies so that they have the technology and the staffing to address the most sophisticated and novel types of evasion, he said.
There are efforts to bring cryptocurrency more firmly under existing AML and tax reporting frameworks, he noted.
“Our view is that financial innovation isn't new, it's not a novel concept, but innovation should occur within the bounds of the same rules that everybody plays by,” Gurule said. “We have these rules and regulations for a reason. They protect the financial systems that are shared by all of us.”
