Can Cryptocurrency be Used to Evade OFAC Sanctions?

The Russian invasion of Ukraine earlier this year prompted the United States and its global allies to hit back with a variety of sweeping sanctions. Unprecedented in history both for their severity and the swiftness with which they were imposed, they have naturally led to wider questions about the role cryptocurrencies could play in future armed conflicts. The aspect of this question we’ll examine here is how, and under what circumstances, cryptocurrencies can be used to evade sanctions.

What are OFAC sanctions?

In the United States, the Department of Treasury’s Office of Foreign Assets Control ("OFAC") administers and enforces economic and trade sanctions based on US national security and foreign policy. Sanctions are aimed at terrorists, drug traffickers, hostile foreign governments, and other bad actors, and are meant to punish them by making it harder for them to conduct their activities.

Two famous, recent examples of sanctioned nations are Iran and Venezuela, and it will prove useful to examine them in more detail.

Why have Iran and Venezuela been sanctioned?

Iran has been sanctioned numerous times in recent history, with the latest sanctions putting them on the Treasury Department’s Financial Action Task Force (FATF) blacklist owing to the Iranian government’s alleged financing of terrorism.

Venezuela has similarly been the subject of numerous sanctions, including, most recently, the sanctioning of several high-profile individuals rumored to have been involved in illegally influencing the country’s presidential election.

How are Iran and Venezuela using crypto to bypass OFAC sanctions?

The basic strategy deployed by the Iranian central bank to elude sanctions has been to allow miners to generate electricity for mining with the country’s vast oil reserves, then requiring them to sell the bitcoin to the central bank. These bitcoin can then pay for goods and services, effectively allowing Iran to sell oil for imports as it normally would (albeit with a few more workarounds).

Though the picture is less clear in Venezuela, there are nevertheless signs that the country’s leadership is looking to evade sanctions using cryptocurrencies. In 2018, for example, taxes at a major Venezuelan airport were collected in bitcoin before being converted via foreign exchanges into dollars held by banks inside the country, violating sanctions by building foreign currency reserves. And though not much has come of the project yet, Venezuela continues to put resources into a state-owned cryptocurrency called the “Petro”, designed for the explicit purpose of evading the economic blockade imposed by the U.S. government.

In late 2020, Nicolas Maduro praised the potential of both the Petro and other cryptocurrencies to help avoid sanctions.

How are blockchain nested exchanges used to evade sanctions?

What are nested exchanges and how do they work?

A nested exchange is exactly what it sounds like. It’s an exchange that is hidden within another exchange, obfuscating the owner. The nested exchange achieves this by opening up an account at a ‘host exchange’-- usually a more prominent and trusted company such as Binance–then mirroring all its own client’s trades on the host exchange. On the outside, it looks perfectly legitimate. Hidden inside is an OFAC-sanctioned entity or other bad actor.

The end result is that the nested exchange’s users might not even realize that there is a middleman involved, believing they’re trading directly on Binance. What’s more, it keeps law enforcement in the dark.

Other times, the nested exchange’s users know exactly what’s going on, and have chosen to use a nested exchange because of its lax adherence to Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations.

In either case, there are substantial risks involved. Well-established exchanges will often look for accounts that show signs of being a nested exchange, such as unusually large trades, and suspend them if they look suspicious.

When that happens the coins held by the nested exchange are forfeited, meaning its users could lose all the capital invested in those accounts.

What are the implications for enforcement of Russian sanctions?

Cryptocurrencies are playing a central role in the ongoing war between Russia and Ukraine. The U.S. Treasury has responded to Russia’s escalations by ramping up OFAC sanctions, while also imposing SWIFT sanctions against key Russian entities for the first time ever.

Cryptocurrencies have ostensibly helped fund Ukrainian resistance efforts through various donation portals. But they may also provide pathways, as yet undetected, for sanctioned Russian parties to skirt sanctions and sidestep punitive measures taken by the United States and its allies, much like Venezuela and Iran are doing.

Nested exchanges enable bad actors to move significant sums of cryptocurrency with little oversight, enabling terrorist financing and money laundering. Despite a largely-united effort by Western powers to cut off Putin’s money faucets, nested exchanges could provide Russian entities with a way to circumvent traditional banking infrastructure.

Investors should be able to trust the cryptocurrency exchanges they use. If a trading platform is quick to approve new users, takes a relaxed view toward KYC/AML requirements, and lacks transparency with its liquidity levels, there is a possibility they may be operating as a nested exchange. Those are some simple rules to operate by to steer clear of the law, especially given that technology exists today to identify illegitimate nested exchanges.

The ongoing war between Ukraine and Russia carries significant ramifications for any U.S.-based entities using digital assets or conducting business (directly or indirectly) with Russia. While domestic policy is still catching up to the breakneck innovation in blockchain, the US government’s OFAC sanctions send an unmistakable message: bypass them at your own risk.

To learn more about how to identify nested exchanges, please contact us at [email protected]

Trent Fowler

Read more posts by this author.

Subscribe to Elementus

Get the latest posts delivered right to your inbox.

or subscribe via RSS with Feedly!