Russians will find it hard to use cryptocurrency for large sanctions evasion

The U.S. government has warned financial institutions to be wary of individuals facing sanctions due to the Russian invasion of Ukraine trying to use digital assets to protect their wealth. In-place protocols, however, will help prevent large-scale sanctions evasion via cryptocurrencies.

The U.S. Treasury Department's Financial Crimes Enforcement Network, or FinCEN, issued an alert March 7, asking financial institutions to look out for transactions sent from or to suspicious internet protocol addresses, as "sanctioned persons, illicit actors, and their related networks or facilitators may attempt to use [convertible virtual currency] and anonymizing tools to evade U.S. sanctions."

"An institution that handles crypto currently is under a higher degree of focus from regulators, in light of the concern that digital assets can be used for facilitation of money laundering," said Richard Levin, partner at Nelson Mullins and the chair of the firm’s fintech and regulation practice.

Trading via unhosted wallets and decentralized crypto exchanges could be one way Russian individuals and entities attempt to skirt sanctions.

Crypto wallets store private keys, or passwords, that let users access crypto registered on a blockchain and then transact the currency. Unhosted wallets sit outside the centralized exchanges and operate without any intermediary or governance. They are not necessarily illegal, but they could be misused like any other technological innovation, according to Liat Shetret, director of regulatory affairs and compliance policy at Solidus Labs, a crypto market surveillance company.

“When it comes to crypto and at this particular moment, banks should be revisiting their risk assessments and revisiting their potential exposure points and gaps that they might have to crypto, and applying mitigation controls around that,” Shetret said.

Unlikely to completely detach

Using unhosted wallets and decentralized exchanges allow users to transact on a pseudonymous basis, but it does not mean crypto transactions can be easily detached from the regulated financial system, said John Popeo, partner at bank consultancy The Gallatin Group. Transactions can be traced on the blockchain until the moment the funds are converted to fiat currency, and the action of moving funds into a suspicious crypto wallet will raise a red flag, Popeo said.

In addition, various crypto companies have pursued licenses and charters and deep connectivity with banks to operate in banking and payments. Regulated money transmitters, such as Coinbase Global Inc. and Kraken Bitcoin Exchange, handle the majority of crypto transactions.

Not only are the crypto platforms obligated to ensure thorough know-your-customer and anti-money laundering measurements, but banks that allow their customers to interact with those crypto wallets must also permit the flow of funds. Network effects strengthen the governance, since every regulated institution, either banks or regulated crypto platforms, has to ensure compliance to sanctions rules, Levin said.

The U.S. dollar's exposure to Russian rubles by way of crypto appears insignificant based on daily transaction volumes on select exchanges, according to data from blockchain data firm Chainalysis. As of March 7, the volume at its peak in late February was less than $80 million a day.

The Russian sanctions are not the first occasion when regulators scrutinized the role of crypto. In October 2018, FinCEN warned that the Iranian regime might use virtual currencies to evade sanctions. On Jan. 30, 2020, the Office of the Comptroller of the Currency issued a cease and desist order to M.Y. Safra Bank FSB, for its deficiency in compliance when opening accounts for digital asset customers.

Regulators have also called out the risks of unhosted wallets. On Jan. 31, the Department of the Treasury proposed to amend regulations implementing the Bank Secrecy Act. The new rules would require banks and money service businesses to better track and verify users of unhosted wallets, according to a document published on the Federal Register.

Further compliance efforts

Sen. Elizabeth Warren, D-Mass., on March 17 introduced a bill seeking to enhance sanctions compliance by digital asset trading platforms, co-sponsored by multiple Senate Democrats. But Sen. Pat Toomey, R-Pa., expressed concerns on drawing the connection between crypto and Russian sanctions evasion, since multiple agencies across the administration had not detected evidence of crypto being used in sanctions evasion in any significant way.

"It is unlikely that designated persons would move around large quantities of crypto now. Russia's elite and financial authorities have been preparing for sanctions for some time. And all of these transactions would be recorded on the blockchain, permanently," according to a spokesperson for Chainalysis.

In September 2021, the Office of Foreign Assets Control, the sanctions regulator under the U.S. Treasury Department, issued sanctions on Russia-based cryptocurrency over-the-counter broker Suex. The investigation, aided by Chainalysis, found Suex facilitated transactions made by ransomware actors, scammers and darknet market operators, and helped convert crypto into cash in Moscow, St. Petersburg and potentially outside of Russia, according to a press release.

While blockchain can be misused, it is still a misconception that this technology inherently benefits bad actors, said Mike Cagney, CEO of Figure Technologies. Figure developed the Provenance blockchain used by the USDF Consortium, the bank-backed blockchain payments network. The network only permits transactions between wallets that have passed know-your-customer screenings, Cagney said.

"Nothing is 100% foolproof. But in general, there is nothing unique about crypto, or blockchain, or digital assets that is any different from the normal KYC [know-your-customer] process," Cagney said.