• Sat. May 21st, 2022

Cryptocurrencies are not the main threat to the sanctions regime

ByHazel R. Lang

Mar 26, 2022

Last week, Senator Elizabeth Warren (D-MA) introduced the Digital Assets Sanctions Compliance Enhancement Act, which she argue is needed to close loopholes that could allow Russian oligarchs to evade sanctions by using cryptocurrencies. The United States and its allies have imposed a series of increasingly broad sanctions against Russia, with a double objective: to pressure Vladimir Putin and his influential advisers to end the war in seizing their assets and distorting their way of life, and cutting off access to resources that could help fuel the Russian war machine. If Russia’s billion-dollar economic elite can simply shift their wealth into digital assets and trade them freely, this move will decapitate the sanctions regime. But fears that cryptocurrencies will function as a sanctions loophole belies at least three myths about the technology and risks diverting time and resources from other, more effective forms of economic government.

First, cryptocurrency is a medium of exchange that uses encryption techniques to control the creation of units and verify the transfer of funds. Unlike the dollar, which is controlled by the Federal Reserve and the Treasury Department for monetary and fiscal policy, cryptocurrency is not under government control. Instead, transactions take place on a decentralized blockchain, which is a ledger that permanently and publicly records all transactions. But decentralization is not synonymous with anonymity or lack of accountability. On the contrary, since all transactions are public, oligarchs transferring money are in many cases open to public scrutiny. Transactions by oligarchs may be pseudonymous, but law enforcement is usually wary of large transactions, which is how a notorious couple who laundered billions in cryptocurrency were recently foiled. The amount of money needed to make a difference in terms of circumventing sanctions would also be a red flag.

Second, and perhaps more fundamentally, the ruble-based assets of the Russian oligarchs can only be converted into cryptocurrency if they find a buyer. For example, if they tried to buy bitcoin, they would find ruble-bitcoin very unattractive pair, pushed inauspiciously by the number of average Russians trying to buy Bitcoin. The oligarchs could therefore struggle to find buyers at these volumes, and they would also likely pay an unattractive premium. Along the same lines, most of the assets held by Russian elites have been frozen and the amount of crypto liquidity is a fraction of the global currency market, which creates additional problems for people looking to move large amounts of capital via cryptocurrency.

Third, many crypto exchanges have physical locations that create vulnerability to existing national sanctions regimes. For example, Coinbase is an American company and the largest cryptocurrency exchange by volume. On the one hand, Coinbase maintains its commitment to decentralization and the inoculation of central government control. On the other hand, Coinbase has an incentive to avoid draconian regulatory initiatives, and therefore an incentive to comply with government sanctions.

Indeed, although early statements of the company suggested that Coinbase would not block Russian transactions, they have since reverse course, saying they are committed to abiding by the sanctions and that “sanctions play a vital role in promoting national security and deterring unlawful aggression.” Since exchanges like Coinbase are subject to “know your customer” regulations, they can easily identify and freeze accounts held by Russian elites.

Decentralized exchanges like dYdX, which rely on peer-to-peer technology, may pose a greater threat to the sanctions regime, as such exchanges are not subject to “know your customer” laws, allowing Russian elites to hide their identity more easily. That said, decentralized exchanges can still to watch account activity and large transactions can still alarm the government. Additionally, the volume of Binance, Coinbase, and other centralized exchanges far exceeds decentralized exchanges, and these decentralized exchanges do not allow trading dollars, which means someone must be entered via cryptocurrency. to start.

Some observers might object that there might be other crypto workarounds to the sanctions regime. For example, Russia’s savvy elites can use “cryptomixing services,” which disaggregate large exchanges into smaller, less visible ones in order to evade detection; the Financial Crimes Enforcement Network recently Published a warning to this effect. Mixers are essentially black boxes that blur the link between senders and receivers in crypto transactions. They do this by aggregating all the cryptos that enter the mixer so that it cannot be observed that a sender has transferred funds into the mixer and a receiver has obtained funds from the mixer, but not that the receiver received the funds from a specific sender.

But again, this method raises practical and anonymity issues for the Russian elite – it would be inefficient and cumbersome to mix large amounts through mixers in this way, and many crypto exchanges Mark currency that has passed through a mixer as “tainted”, making it difficult to trade. Blenders may work well for small amounts and for citizens trying to evade, say, Putin’s controls, but they’re bad for trying to hide hundreds of millions of dollars. The crypto thieves described above were caught even after the mix due to the large amounts at stake.

What about the possibility that the Russian government could mine Bitcoin or other digital currencies to power its military machine? Some evidence suggests, for example, that Iran mined Bitcoin to evade sanctions. However, doing it in large volumes is incredibly expensive – mining takes both time and energy, which is why Iran finally banned Bitcoin mining after causing a series of blackouts. To undermine the sanctions regime, Russia would need to mine astronomical volumes, making it an ineffective, impractical and therefore unlikely way to escape.

Given the magnitude of these challenges, there is no proof to suggest that the crypto has been or will be used in the nefarious way suggested by lawmakers. Moreover, even if some evasion occurs through these channels, it is likely to be small in scale and therefore not pose a significant threat to the sanctions regime. The main issues around sanction evasion relate to older, non-cryptographic issues: first, “dark knights” or Kremlin-friendly states that will pass resources through their hands; and second, hidden and otherwise liminal assets in tax havens or places with strong property rights that actually belong to Putin’s cronies. The first is of great concern to the State Department, particularly in the context of Chinese aid to the Russians. The latter involves the diligent cat-and-mouse task of untangling front companies. Circumvention of sanctions existed for decades before the advent of cryptocurrencies.

As such, government officials would have to spend time and resources that would otherwise be spent on cracking cryptographic flaws to enforce the existing sanctions regime, which is take a toll on Russian elites and exploring other more conventional means of economic government.

Sarah Kreps is John L. Wetherill Professor of Government, Adjunct Professor of Law, and Director of the Tech Policy Lab at Cornell University. She is also a Nonresident Senior Fellow in the Artificial Intelligence and Emerging Technologies Initiative at the Brookings Institution. You can find her on Twitter at @sekreps.

Richard Clark is a postdoctoral fellow at the Niehaus Center for Globalization and Governance at Princeton University and an incoming assistant professor of government at Cornell University. His research has been published in the American Journal of Political Science, Journal of Politics, and International Organization, among others. You can find him on Twitter @Ricky__Clark.

Adi Rao holds a Ph.D. student and researcher at Cornell University’s Tech Policy Lab.

Picture: Reuters.

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