Why sanctions evaders can’t hide in cryptocurrency

Using crypto transactions to avoid financial sanctions is fraught with difficulties, particularly when it comes to converting those funds into traditional fiat currency
British Prime Minister Boris Johnson speaks during a joint press conference with Prime Minister of Estonia and Secretary General of NATO at the Tapa Army Base on March 1, 2022 in Tallinn, Estonia. - British Prime Minister Boris Johnson said on a visit to Poland on March 1, that the West would keep up sanctions pressure on Russian President Vladimir Putin's regime indefinitely after it invaded Ukraine (Photo by Leon Neal / POOL / AFP) (Photo by LEON NEAL/POOL/AFP via Getty Images)

As Russian tanks rolled into Ukraine and cities came under attack, the world watched in horror and financial aid for those trapped in the country began flooding in.

By early March, almost $100m had been donated to Ukraine in cryptocurrency alone, underlining the unique opportunity crypto presents for sending money directly to people in war zones to support relief efforts.

Meanwhile, for those trapped in Russia, cryptocurrency also provides a haven against the falling ruble and government-imposed capital controls. It equally highlights the opportunity crypto presents for helping individuals maintain their economic freedom.

“This is a good use case for why you may not want to be dependent on a [fiat] currency that is collapsing in value and being reliant on banks that can no longer send money on your behalf to the rest of the world,” says Benjamin Sauter, a crypto lawyer at global disputes and investigations firm Kobre & Kim.

As soon as you move towards dollars or euros or pounds, then you will most likely have to deal with a crypto company that’s subject to sanction policies itself

Yet while crypto can be a force for good, there remain concerns that it can be used to facilitate wrongdoing. As Western governments placed financial sanctions on Russian businesses and individuals, one question loomed large: could sanctions be evaded by shifting assets into crypto?

The answer is, not as easily as you might think. 

“Cryptocurrency, in some ways, is no different than traditional finance,” says Sauter. “Law-abiding cryptocurrency exchanges and other services that are potential on-ramps and off-ramps for crypto are aware of who those sanctions apply to; just like any traditional compliant bank, would not allow those sanctioned entities to move their funds.”

Another reason why evading sanctions using crypto is a challenge is the size of the overall market, which is about $3tn. By contrast, the value of the global real estate market rose to almost $330tn in 2020, according to Savills. 

“The crypto market has grown rapidly but is there actually the liquidity to wash quite substantial amounts of money? A lot of people would argue no,” says Deborah Hutton, a partner at Eversheds Sutherland.

Crypto is not completely anonymous 

The volatility of the market may also make crypto less suited for storing substantial assets, and its pseudo-anonymous nature means it is difficult to entirely conceal ownership. Any time someone wants to convert fiat currency into crypto or cash back into fiat, they will need to use an exchange that will likely comply with existing anti-money laundering (AML) and know-your-customer (KYC) regulations.

“There may have initially been a misunderstanding that things were a lot more anonymous than they really are,” Hutton says. “We are looking at a global regulatory approach. We’re looking at the rise of blockchain analysis tools. And we’re also looking at more sophisticated investigation procedures.”

One company that is developing blockchain and crypto monitoring tools is Chainalysis, which can place alerts on crypto wallets that have been linked to sanctioned individuals or companies.

“If you are a crypto exchange who is interacting directly or indirectly with a sanctioned wallet, you will receive an alert that you’re receiving funds or someone is trying to make a transfer from a sanctioned entity,” says Caroline Malcolm, head of policy at Chainalysis.

Being able to detect indirect fund flows is an essential tool for monitoring if sanctioned accounts are trying to cover their tracks by moving funds in and out of multiple wallets.

“Someone who is trying to evade sanctions is not going to open up an account under their own name and then transfer to another exchange directly, they are obviously going to try and obfuscate that,” Malcolm says. “But even if you’re not transferring directly, we can still see that, maybe three hops away, those funds came from a sanctioned wallet address.”

Sanctions avoidance challenges

One potential way to circumvent AML and KYC rules is to use an exchange in a jurisdiction that might have a more relaxed approach to sanctions compliance.

“You could use offshore entities that don’t follow sanctions policies, so that is one potential weak spot. But as soon as you move towards dollars or euros or pounds, then you will most likely have to deal with a crypto company that’s subject to sanction policies itself,” says Teunis Brosens, head economist for digital finance and regulation at ING.

The growth in decentralised finance apps may also offer a way for sanctioned individuals to move their crypto assets without needing to use a traditional exchange.

Sauter says: “That’s not going to result in cash, but you can change assets into different forms. And you can do it a lot and make it harder to track and obscure the path that assets take and who controls them.”

He explains that mixing services, which break down funds into smaller transactions or exchange them into other cryptocurrencies, can also potentially enable sanctioned individuals to obscure where their funds are heading.

However, while evading sanctions at scale using crypto remains challenging today, it is unlikely to get any easier in the future. Even as the size of the crypto market grows and mainstream adoption reduces the need for on and off ramps to convert funds in and out of fiat.

“Even if you could transact entirely in crypto, pure Bitcoin barter transactions probably aren’t going to get sanctioned billionaires very far,” says Sauter. “And even if we get to the point where there is widespread day-to-day spending adoption, then what you might see evolve is KYC requirements for merchants who do sizable business using crypto.”

The fact that there is a permanent record of all blockchain transactions means investigators can potentially piece together fund movements and wallet ownership as more information becomes available.

Malcolm says: “Blockchain gives you the map of the crypto world and on top of that, we overlay the street signs and the names of the street tell you where to go and who is who. That information is gathered over time, so even if you don’t have a complete picture today, we continually add to that data pool and so you can gradually build up a clearer view of where funds have flowed.”

Therefore, any fears that crypto can be used to sidestep sanctions are largely overblown.