Cryptocurrencies: a way to evade sanctions?

By far, last month’s most debated issue has been the cryptocurrencies’ potential role as a means to evade Western financial sanctions against Russia, following Russia’s invasion of Ukraine. In particular, Russian individuals, firms and institutions could use cryptocurrencies to make international payments, following the disconnection of some Russian banks and financial institutions from the payment messaging system Swift. Indeed, cryptocurrencies potentially allow to make transactions without the need for any intermediary. The data seem to provide evidence for this hypothesis: trading volumes between rouble and Bitcoin and rouble and Tether soared after the announcement of Western sanctions.

Many lawmakers and regulators expressed concerns on this possibility. In Europe, ECB president Lagarde called for a regulatory framework on crypto, hinting at preventing Russia from getting around economic sanctions (here you can find the video). As a consequence, the EU is considering new measures to ensure digital assets are not used to dodge sanctions. The EU also clarified in a press release that crypto assets fall into the category of "transferrable securities" and are therefore included in the scope of sanctions imposed on Russia, a position similar to the one expressed by the Bank of England and the UK Financial Conduct Authority (FCA) in a joint statement clarifying that, since financial sanctions regulations do not differentiate between crypto assets and other forms of asset, the use of crypto assets to circumvent economic sanctions is a criminal offence. In the United States, Fed Chair Powell emphasized the need for cryptocurrencies’ regulation to prevent sanctions’ evasion, a position shared by the secretary of the Treasury Yellen. The Treasury department’s Financial Crimes Enforcement Network (FinCEN) issued a note addressed at US financial institutions, specifying some “red flags” that should indicate an attempt to evade sanctions using cryptocurrencies (here you can find the whole text). The US Department of Financial Services (DFS) said in a press release that it will use blockchain analytics technologies  to help detect exposure to Russian individuals and entities subject to federal sanctions, while the new guidelines included in a  regulation from the Treasury Department’s Office of Foreign Assets Control (OFAC) banned any US person from providing support to the sanctioned Russian individuals and entities, including the transfer of digital currencies or assets. The issue is also being tackled at the international level: the G7 made a joint statement announcing new guidance on crypto sanctions evasion.

A big debate is underway on whether sanctions evasion with crypto is a realistic possibility or not. Insiders and practitioners of the crypto industry deny this possibility. The main arguments used are:

1. the crypto industry is too small, as it doesn’t have sufficient liquidity to meet the needs of a sovereign nation. For a country, that would be hundreds of billions of dollars, while the entire crypto market cap is about $2 trillion;
2. Swift processes every day on average 42 million financial messages. That kind of scale and efficiency cannot be replicated with today’s decentralized financial technology;
3. the use of publicly accessible blockchain renders it not an effective tool for illicit activities, as the open ledger makes movement of money more traceable than using other assets like cash or gold;
4. the idea that some cryptocurrency can be used to bypass sanctions depends on that asset actually being picked up for widespread use, which is not the case at the moment.

A FinCEN representative also said that for Russia is “impossible” to evade sanctions with cryptocurrencies.

But the main argument that casts doubt on the possibility of sanctions workaround using crypto is the fact that the crypto world’s claimed full decentralization is actually a myth. As explained by this paper, the so called decentralized finance (DeFi), referring to the blockchain infrastructure allowing to make financial operation without intermediaries, in a pure peer-to-peer way, is a niche of the whole crypto market, while the bulk of transactions involving cryptocurrencies are mediated by centralized crypto exchanges. The latter, especially in certain countries, are subject to the same KYC/AML regulations applied to traditional financial institutions and as a consequence can block the accounts connected to sanctioned individuals and entities. US president Biden and Ukraine’s vice-prime minister Fedorov asked indeed the major crypto exchanges to freeze the accounts of Russian individuals and entities. While initially crypto exchanges like Coinbase and Kraken stated that they would not have banned Russian accounts, some of them, like CoinZoom, Binance and the NFT marketplace OpenSea subsequently announced that they will block the accounts owned by sanctioned individuals and entities (even if, after this announcement, Binance has been accused by Ukrainian crypto exchange KUNA founder Michael Chobanian to cooperate with the Russian government). In the meantime, the US Justice Department announced that it will investigate and prosecute people and financial institutions, including crypto exchanges, that aid Russians in hiding their assets from sanctions, and the federal council of Switzerland stated that Switzerland will freeze all crypto assets held within its borders that are owned by Russians and the country’s businesses that have had sanctions imposed by the EU.

As a consequence, some of the so called “privacy coins” like Monero, that unlike traditional cryptocurrencies use a cryptographic process to ensure that transactions cannot be linked to wallet holders and are untraceable, experienced a big price jump. Indeed, some analysts explain this jump as the market reaction after the developments in the cryptocurrency industry connected to Western sanctions. By the same token, the biggest price rise registered in the crypto world is the one of the algorithmic stablecoin Terra Luna (UST), pegged to the dollar, whose price rose by 114% from the start of the war to the end of March (here you can see the graph of the market price). Being an algorithmic stablecoin, Terra Luna is decentralized (stablecoins are generally managed by a central entity; for a brief overview of the different types of stablecoins and their functioning, see this article), and this property  seems recently to be rewarded by investors.

Meanwhile, some of the latest Russia’s moves add weight to the hypothesis that the country is considering cryptocurrencies as a way to cope with financial sanctions. Firstly, the Chairman of the Congressional Energy Committee, Pavel Zavalny, said that Russia is open to accepting bitcoin payments for its natural gas and energy exports. Secondly, the Central Bank of Russia (CBR) added the country’s biggest  bank, Sberbank, to its register of information system operators for digital financial assets. As clarified from the same CBR, inclusion in the registry allows companies to issue digital financial assets and exchange them between users within their platforms. This stands in contrast with the traditional CBR attitude towards the crypto world, as until two weeks before this decision the central bank reiterated the proposal to ban the issuance, mining and circulation of cryptocurrencies in Russia.

If the role of cryptocurrencies as a workaround for Russia is uncertain, it is certain their role in transferring funds to the Ukraine’s government. Indeed, the latter has raised more than $100mn in cryptocurrency donations since the war started. This was part of a deliberate strategy pursued by Ukraine to cope with restriction faced by its bank and to accelerate international transfers, that without cryptocurrencies would have taken days to be delivered. Ukraine’s government has also launched a crypto donation website, backed by the crypto exchange FTX, which is converting donations into fiat for deposit at the National Bank of Ukraine.