Crypto's impact on sanctions: Are regulators' concerns justified?

Published at: Nov. 30, 2021

The use of cryptocurrencies to evade international sanctions from various international governmental organizations like the United Nations (UN), the International Monetary Fund (IMF) and the World Bank, among others, has been a concern for regulators ever since the creation of cryptocurrencies.

The rapidly increasing adoption of digital currencies in the last two years makes this discussion more important than ever, especially with the advent of central bank digital currencies (CBDCs) like the digital yuan.

In an interview on Nov.17, United States Deputy Treasury Secretary Wally Adeyemo said that the efficacy of U.S. sanctions would not be undermined by central bank digital currencies.

Adeyemo's remarks follow comments from sanctioned Russian oligarch Oleg Deripaska, who urged the Russian government to use Bitcoin to evade U.S. sanctions and even weaken the dominance of the U.S. dollar. Deripaska said, “The U.S. had realized long ago that uncontrolled digital payments are capable of not only nullifying the effectiveness of the entire mechanism of economic sanctions but also taking down the dollar as a whole.”

The Biden administration at large has taken a hard stance against cryptocurrency firms that are abetting such causes. It has found cryptocurrency exchanges guilty of enabling ransomware attacks facilitated through rival countries.

Ransomware attacks are the tip of the iceberg

In September, the Treasury Department Office of Foreign Assets Control sanctioned over-the-counter broker Suex by adding it to the list of Specially Designated Nationals for whom assets are blocked and any U.S. persons are prohibited from engaging in financial transactions with them. The broker’s offices in Moscow and Prague were also listed by the government agency as a part of their sanctions, including 25 cryptocurrency addresses for Bitcoin (BTC), Ether (ETH) and Tether (USDT).

More recently, on Nov. 8, the regulator sanctioned the cryptocurrency exchange Chatex and seized $6.1 million in cryptocurrency tokens from the firm. Both these exchanges were sanctioned for the same reasons, i.e. accepting cryptocurrencies that were used to pay off hackers for ransomware attacks.

Cointelegraph discussed these sanctions with Ari Redbord, the head of legal and government affairs at TRM Labs — a blockchain intelligence protocol. Redbord previously served as a senior adviser to the Deputy Secretary and the Undersecretary for Terrorism and Financial Intelligence at the United States Treasury.

Redbord told Cointelegraph, “These are non-compliant nested exchanges or parasite virtual asset service providers that nest on the infrastructure of larger compliant exchanges in order to take advantage of their speed and liquidity.”

Exchanges such as these live in the shadows of the largely compliant cryptocurrency ecosystem and do not have adequate compliance procedures in place to avoid illicit financial risks. Redbord mentioned further the administration’s stance on the issue:

“The administration has been very clear that ransomware is not a crypto problem. It is a cyber problem and the focus should be on hardening cyber defenses. Treasury has been very intentional in its actions — only going after the illicit underbelly of the crypto ecosystem — for example, parasite VASPs and darknet mixing services — rather than the overwhelmingly licit and growing crypto economy.”

Terrorist financing with cryptocurrencies is also a major concern for regulators. Indeed, it is one of the primary motivators behind the Indian regulator’s intention to ban cryptocurrencies, which led to a panic sell in the region when the development was revealed.

Redbord mentioned that over the last year, there has been a global shift to a “post-post” 9-11 world wherein the battlefield is now predominantly digital. He added, “We have seen cryptocurrency used in terrorist financing, ransomware payments and programmatic money laundering by nation-state actors such as North Korea. But, we have also seen law enforcement use blockchain analytics tools [...] to track and trace the flow of funds in order to mitigate the risks posed by these illicit actors.”

The fact that the majority of cryptocurrencies and the blockchains enabling them are open-sourced means that law enforcement, regulators and financial institutions have better visibility of the flow of funds than in fiat-enabled transaction mechanisms. In order to effectively ensure that cryptocurrencies aren’t being used in the evasion of sanctions, however, it is essential that financial watchdogs have an enhanced understanding of the asset class and technology that backs it.

Charlie Chen, chief marketing officer of decentralized finance protocol Horizon Finance, told Cointelegraph, “Governments and financial institutions have not yet learned how to work with cryptocurrencies, so they really can be chosen to commit crimes. The world is full of stories like that of the Silk Road. There are real criminal cases involving cryptocurrencies and there are convictions, which means there is evidence.”

CBDCs to have minimal impact on sanctions

Another aspect of the cryptoverse that could potentially impact the sanctions is central bank digital currencies. China is currently the leader where CBDCs are concerned with the most advanced CBDC program — the Digital Currency Electronic Payment or the digital yuan.

In the past, major Chinese banks with operations in the U.S. have made tentative steps to comply with American sanctions. But some have worried that the adoption of this CBDC in global markets could lead to the weakening of the dollar over time unless the United States comes up to pace with China’s program.

Chen, however, believes that there is little chance that CBDCs could be used to bypass economic sanctions. He said, “At the moment, most international transactions are made in U.S. dollars, and Russian companies will find it problematic to persuade their partners to abandon transactions in USD in favor of a digital ruble.”

He added that the existing mechanisms and algorithms for tracking transactions already allow for detecting suspicious transactions, and in the future, these mechanisms would only become more advanced and efficient.

Currently, there are no barriers that would prevent paying a sanctioned party for a service with cryptocurrencies like Bitcoin. Even with the use of popular cryptocurrencies and whitelisted wallets, these transactions would go unnoticed by the financial regulators. However, Chen explained that problems would arise when the tokens are exchanged for fiat currencies and transferred to the bank account of the sanctioned party.

Chen added, “If you are using a major exchange like Binance, this bank transfer will not work. Therefore, you will have to use smaller exchange services that are so popular in post-Soviet space.”

While cryptocurrencies grow more mainstream every day, in many jurisdictions around the world, they remain largely unregulated and adoption is still nascent. As such, the ability of cryptocurrencies to be used at the scale of a nation-state to avoid sanctions remains to be determined.

One thing is clear, whether crypto turns out to be the next iteration of money or merely another form of investment, regulators are monitoring its use in illicit activities such as sanction avoidance.