Crypto could be Russia’s secret weapon in sanction fight

When the United States barred Americans from doing business with Russian banks, oil and gas developers and other companies in 2014, after the country’s invasion of Crimea, the hit to Russia’s economy was swift and immense. Economists estimated that sanctions imposed by Western nations cost Russia $US50 billion ($69.1 billion) a year.

Since then, the global market for cryptocurrencies and other digital assets has ballooned. That is bad news for enforcers of sanctions and good news for Russia.

Russia is home to some of the world’s biggest Bitcoin miners. .Credit:Bloomberg

On Tuesday, the Biden administration enacted fresh sanctions on Russia over the conflict in Ukraine, aiming to thwart its access to foreign capital. But Russian entities are preparing to blunt some of the worst effects by making deals with anyone around the world willing to work with them, experts said. And, they say, those entities can then use digital currencies to bypass the control points that governments rely on — mainly transfers of money by banks — to block deal execution.

“Russia has had a lot of time to think about this specific consequence,” said Michael Parker, a former federal prosecutor who now heads the anti-money laundering and sanctions practice at Washington, D.C., law firm Ferrari & Associates. “It would be naive to think that they haven’t gamed out exactly this scenario.”

Sanctions are some of the most powerful tools the US and European countries have to influence the behaviour of nations they don’t consider allies. The US in particular is able to use sanctions as a diplomatic tool because the dollar is the world’s reserve currency and used in payments worldwide. But American government officials are increasingly aware of the potential for cryptocurrencies to lessen the effect of sanctions and are stepping up their scrutiny of digital assets.

To apply sanctions, a government makes a list of people and businesses its citizens must avoid. Anyone caught engaging with a member of the list faces heavy fines. But the real key to any effective sanctions program is the global financial system. Banks around the world play a major role in enforcement: They see where money comes from and where it is bound, and anti-money laundering laws require them to block transactions with sanctioned entities and report what they see to authorities. But if banks are the eyes and ears of governments in this space, the explosion of digital currencies is blinding them.

Banks have to abide by “know your customer” rules, which include verifying their clients’ identities. But exchanges and other platforms that facilitate the buying and selling of cryptocurrencies and digital assets are rarely as good at tracking their customers as banks are, even though they are supposed to follow the same rules. In October, the US Treasury Department warned that cryptocurrencies posed an increasingly serious threat to the US sanctions program and that US authorities needed to educate themselves about the technology.

Should it choose to evade sanctions, Russia has multiple cryptocurrency-related tools at its disposal, experts said. All it needs is to find ways to trade without touching the dollar.

The Russian government is developing its own central bank digital currency, a so-called digital ruble that it hopes to use to trade directly with other countries willing to accept it without first converting it into dollars. Hacking techniques like ransomware could help Russian actors steal digital currencies and make up revenue lost to sanctions.

Should it choose to evade sanctions, Russia has multiple cryptocurrency-related tools at its disposal, experts said. All it needs is to find ways to trade without touching the dollar.

And while cryptocurrency transactions are recorded on the underlying blockchain, making them transparent, new tools developed in Russia can help mask the origin of such transactions. That would allow businesses to trade with Russian entities without detection.

There is a precedent for these kinds of workarounds. Iran and North Korea are among countries that have used digital currencies to mitigate the effects of Western sanctions, a trend that US and United Nations officials have recently observed. North Korea, for instance, has used ransomware to steal cryptocurrency to fund its nuclear program, according to a UN report.

In October 2020, representatives of Russia’s central bank told a Moscow newspaper that the new “digital ruble” would make the country less dependent on the US and better able to resist sanctions. It would let Russian entities conduct transactions outside the international banking system with any country willing to trade in digital currency.

Russia could find willing partners in other nations targeted by US sanctions, including Iran, that are also developing government-backed digital currencies. China, Russia’s largest trading partner in both imports and exports according to the World Bank, has already launched its own central bank digital currency. The country’s leader, Xi Jinping, recently described China’s relationship with Russia as having “no limits.”

The developing system of central banks directly exchanging digital currencies creates new risks, said Yaya Fanusie, a fellow at the Centre for a New American Security who has studied the effects of cryptocurrency on sanctions. “The lessening of US sanctions power comes from a system where these nation states are able to do transactions without going through the global banking system.”

In early February, independent sanctions monitors told the UN Security Council that North Korea was using cryptocurrencies to fund its nuclear and ballistic missile program, according to Reuters. (A spokesperson for Norway’s permanent mission to the UN confirmed the existence of the report, which has not yet been made public.) In May, consulting firm Elliptic described how Iran was using revenue from Bitcoin mining to make up for the limitations on its ability to sell oil because of sanctions.

Sanctioned Russian entities could deploy their own evasion strategy, using ransomware attacks. The playbook is straightforward: A hacker breaks into computer networks and locks up digital information until the victim pays for its release, usually in cryptocurrency.

Russia is at the centre of the growing ransomware industry. Last year, about 74 per cent of global ransomware revenue, or more than $US400 million ($560 million) worth of cryptocurrency, went to entities that are probably affiliated with Russia in some way, according to a February 14 report by blockchain-tracking firm Chainalysis.

Illegal funds have also flowed into Russia through a dark web marketplace called Hydra, which is powered by cryptocurrency and handled more than $US1 billion ($1.4 billion) in sales in 2020, according to Chainalysis. The platform’s strict rules — sellers are allowed to liquidate cryptocurrency only through certain regional exchanges — have made it difficult for researchers to follow the money.

A digital ruble would lessen Russia’s reliance on the US dollar.Credit:AP

“We know that there’s no questions asked, and we know that Hydra operates not just throughout Eastern Europe but throughout western Europe,” said Kim Grauer, director of research at Chainalysis. “There’s definitely cross-border business happening.”

There are signs that the US is stepping up its monitoring of cryptocurrency activity. On February 17, the US Justice Department announced it had created a new a national cryptocurrency enforcement team, a move that seemed to emphasise that federal prosecutors were paying extra attention to bad behaviour among cryptocurrency users.

Administration officials are also urging the cryptocurrency industry to implement internal controls that prevent bad actors from using their services. In October, the US Treasury Department published a 30-page sanctions-compliance manual recommending that cryptocurrency companies use geolocation tools to weed out customers in sanctioned jurisdictions. In many cases, the report said, crypto companies have taken months or years to implement such compliance procedures.

That may change as the industry starts to mature. Chainalysis offers a “know your transaction” tool that alerts companies when blacklisted entities use their services. Last year, the company doubled its number of private-sector customers, many of whom use the compliance tool.

But savvy cryptocurrency users can find ways around a blacklist.

“A Treasury designation of a crypto wallet address is not foolproof,” said Fanusie of the Centre for a New American Security. “That designated actor can still open up a new wallet elsewhere. You can do that quite easily.”

This article originally appeared in The New York Times.

The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.

Most Viewed in Business

From our partners

Source: Read Full Article