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Russia’s invasion of Ukraine triggered an unprecedented campaign of financial and trade sanctions.
Within a week of Russian troops entering Ukraine in late February, the United States, EU, Great Britain, Canada and other countries imposed a wide range of sanctions on Moscow. These include measures targeting Russia’s largest commercial banks, the Central Bank of Russia and – in what is being called the “nuclear option” – the exclusion of several large Russian banks from the Society for Worldwide Interbank Telecommunications (SWIFT).
By comparison, it took a decade of diplomacy for the United States to convince other governments to impose a similar set of restrictions on Iran’s financial sector.
These sudden bans on doing business with the Russian banking system have led many observers – such as Elizabeth Warren, a US senator, and Bruno Le Maire, the French finance minister – to suggest that crypto-assets could provide Russia with an alternative mechanism to facilitate transactions and avoid sanctions.
Can Russia Use Crypto Assets to Avoid Sanctions? If so, how? The answer is not simple, but it comes with important implications for compliance and risk management professionals everywhere.
Insufficient tool to avoid sanctions
To understand whether cryptoassets can fill the gap for Moscow, it is important to consider some facts about the Russian economy and financial system.
Russia is the world’s 11th largest economy measured by total GDP. Its total annual exports exceed 400 billion dollars, and its total annual imports exceed 200 billion dollars. Meanwhile, the total assets of the Russian banking sector are $1.4 trillion.
By comparison, the total market capitalization of all cryptoassets is $1.7 trillion. To fill the gap that sanctions have created in its ability to transact freely with the United States and other countries, Russia would have to find a way to use almost every unit of every crypto-asset in existence.
This is completely impractical, and made worse by the fact that digital assets are not widely accepted for payments or trade settlement. It is also hard to understand why Russia would want to replace its falling ruble with another highly volatile asset.
Moreover, avoiding sanctions in cryptoassets is a risky business. All digital asset transactions are recorded on open, public ledgers – or blockchains – making transactions highly traceable. Sanctioned actors risk detection if they make large transfers. Indeed, many cryptoasset companies are already implementing sanctions compliance solutions using blockchain analytics to detect wallets belonging to blacklisted actors.
Cryptoassets alone simply do not offer sanctioned Russian financial institutions – or other sanctioned Russian entities and individuals – a viable means of doing global business on a large scale.
Low hanging fruit
However, Russia is likely to use crypto-assets on a limited scale as a method of raising funds as it feels pressure from sanctions. While cryptoassets cannot provide it with complete relief, there are several relatively simple methods Russia can employ to obtain cryptoassets in the face of sanctions.
The first is through mining Bitcoin (BTC) or other crypto assets. Mining is an energy-intensive process of securing cryptoasset networks by verifying transactions. Iran offers an example that Russia could follow to exploit mining.
Faced with sanctions, Iran has established a licensing regime for bitcoin mining in the country. To mine digital assets, Iran is diverting excess fossil fuel reserves that it is unable to export due to sanctions. It then receives the BTC that miners – mostly from China – receive as a reward for validating Bitcoin transactions. Iran can then use the digital asset to pay for imports or convert them into cash.
The volume of mining there is significant: roughly 4.5% of all BTC is mined in Iran – enough to generate $1 billion in revenue for the regime.
Russia is in a good position to use mining as a source of financing. In January, President Vladimir Putin said Russia had a “competitive advantage” in this regard, thanks to its vast oil and gas reserves. About 11% of Bitcoin mining already takes place in Russia – primarily in Siberia – so it would take minimal effort for sanctioned Russian entities to look at Bitcoin mining as a source of income.
Belarus – which has also been the target of extensive sanctions for supporting the invasion of Ukraine – reportedly wants to use its idle industrial capacity to mine bitcoins.
Another way for Russia to obtain cryptoassets is through cybercrime. Here, North Korea offers an example that Russia might try to emulate. North Korean cybercriminals have been involved in a number of high-profile hacks on cryptoasset exchanges. These cyber thefts have allowed the country to obtain hundreds of millions and possibly even billions of dollars in crypto-assets, which are then converted into renminbi and laundered through Chinese banks.
Amid the crisis with Ukraine, the United States and other governments have expressed concern that Russian-sponsored cyberattacks on the financial sector could intensify. It is well within Moscow’s ability to launch cyberattacks—such as thefts from cryptoasset exchanges or ransomware campaigns—that could net it a significant amount of cryptocurrency.
Russian operatives have previously used Bitcoin to fund espionage in attempts to disrupt US elections, so they already have experience using the reusable crypto-asset.
Finally, Russia could rely on non-compliant crypto-asset exchange services in its efforts to avoid sanctions. Although most of the world’s largest digital asset services implement anti-money laundering (AML) and sanctions controls, there are still some that do not. These high-risk services can be valuable conduits for illegal actors, and in some cases can even be complicit in enabling criminal activity.
The ability of Russian illicit actors to exploit these high-risk crypto-asset exchange services has been revealed in two sanctions by the US Treasury’s Office of Foreign Assets Control (OFAC). In September and November 2021, it sanctioned SUEX and Chatex, two Eastern European-based cryptoasset exchange services that laundered hundreds of millions of dollars in transactions for Russian ransomware gangs.
Faced with strict capital controls and limited access to banking, sanctioned Russian individuals and entities could look to non-compliant exchange services such as SUEX and Chatex to obtain cryptoassets and transfer funds around the world.
Compliance response
Crypto assets may represent only a small component of Russia’s overall sanctions evasion activity. However, political and regulatory scrutiny of the crypto-asset sector will be intense.
On March 2, senior Democratic senators wrote to Janet Yellen, the US Treasury secretary, demanding that the Treasury Department enforce sanctions laws to prevent Russian circumvention using crypto-assets. On March 7, the Treasury’s Financial Crimes Enforcement Network (FinCEN) released an alert on Russian sanctions evasion, and it included red flags about potential evasion involving cryptoassets.
In this atmosphere, it is essential that compliance teams take their responsibilities seriously and apply strong controls.
For example, financial institutions can use blockchain analytics to verify links to cryptoasset wallets controlled by OFAC, EU and UK sanctioned entities. This works similarly to conventional sanctions screening solutions, allowing businesses to proactively block activities with banned actors.
Similarly, compliance teams can work to identify and conduct enhanced analysis of non-compliant crypto exchange services. This includes using crypto-asset transaction data to understand the historical transaction activity of digital asset exchange services, identifying where they may have ongoing ties to sanctioned actors.
With Russia’s invasion of Ukraine showing no signs of abating, compliance teams must remain vigilant.
Originally published by Thomson Reuters © Thomson Reuters.
Sanctions Compliance Financial Services
