Sanctions are the source of a government's foreign policy power and legitimacy. In the old days it was pretty simple, if, as a government, I sanctioned you then you would lose access to many things you needed to do business or survive. This could include restricted access to my country's land, airspace, waterways, people, businesses, raw materials, banks, and currency. The idea was simple, in the best case scenario if I deny access to anything critical for your survival, you would simply stop doing the thing I'm so offended about in order to be allowed access again. At the very least, it would result in ensuring no contact between my entire country and you for the length of time the sanction remained in force, similar to blocking someone on every social media platform you have.
Now where denying access via sanctions gets interesting is that for every control ever put in place, someone will invent a circumvention that you did not think of, for which you now have to come up with new controls. In this article, we focus on cryptocurrency and how it's disrupted the traditional sense of control governments have with regard to the movement of funds.
US Dollars have an OFAC on everything
Looking back into sanctions denying access to the financial system of a country, chief of these being OFAC (US Department of Treasury, Office of Foreign Assets and Control) namely because of how many global transactions utilize the US dollar or flow through US banking institutions through a process known as correspondent banking. This is where the sending bank has to hop money through a series of institutions because they don't have a direct relationship with the receiving bank. Think of it as transiting during connecting flights but for dollars and cents. So to simplify (and because there's a high likelihood) almost all banks adhere to OFAC sanctions making the US's foreign policy now applicable globally.
So, to get around a sanction do I just stop US dollars or US-based banks? The simple answer is YES absolutely. Granted it's easier said than done which is where Cryptocurrency comes into the picture. I'll begin with a caveat that cryptocurrency was not invented specifically to circumvent sanctions, as there are many other arguments for 'less government control' in the financial system. However, considering that cryptocurrency is based on DLT (distributed ledger technology) it doesn't reside in any one place, has no specific nationality, and cannot come under any one nation's jurisdiction. In essence, it is the perfect medium of exchange to evade a sanction.
'Medium' of exchange: as in it does only moderately well
I'm going to emphasize the word medium here because that's exactly how well cryptocurrency fares as a freely accepted exchange of value. Something's value is, after all, only what everyone in the exchange agrees it is, so if, as a business, I do not accept Bitcoin, then its value within the context of this specific contract is absolutely zero. This is where the liquidity of an asset comes into play - how quickly can you turn it into something everyone would accept, say fiat currency. Unfortunately, as you would have surmised by now, conversion of cryptocurrency into fiat currency puts it squarely back within the jurisdiction of a sanction.
The question on every sanctioned party's mind at this point would be how do I go about converting this cryptocurrency into something else without being detected. So far in this article, I have refrained from using the word 'criminal' as over the past few years, increasing numbers of sanctioned parties are on lists despite committing no crime. However, once you cross the line of attempting to conceal the exchange of funds be it through crypto, exchange of commodities, or even layering cash transactions then the crime of money laundering has been committed.
AMLCFT controls and frameworks, yet again
This is where all the recent changes have come into the sanctions sphere, by international surveillance organizations and governments recommending or enforcing stricter controls to the final leg of these transactions as they move outside of crypto and into the exchange of goods and services.
For starters, between 2019 and 2021, the FATF, FinCEN, US Department of Justice, and the UN have all issued directives requiring increased registration and supervision of anyone dealing in cryptocurrency. These controls are required to be at a level similar to any money service business (basically currency exchange businesses and remittance services) which in many countries forces crypto exchanges to register themselves with the central bank and enforce a written AMLCFT framework with a focus on stopping the use of cryptocurrency in international sanctions circumvention. The most significant of these changes would be OFAC hinting that it would like to include digital currency addresses as part of the identifiers for entities on its sanctions list - which if anything, is recognition that this is happening more often than people think.
Great, oodles of information, do I actually have to do something about it?
In essence, new stuff is always happening, and even with cryptocurrency space, once seen as the wild west, sooner or later there will be a sheriff in town. As a business owner, a financial service provider, or even as a fincrime analyst reading this just remember that obligations change, technology progresses, and eventually, the law catches up. Be ready and be mindful that this will be a rapidly changing space over the next decade and to keep up to date to ensure that you aren't caught unawares, being party to an offending transaction that could land your business in hot water.
And as always, if any of this is overly complex and you'd like to have a chat about your business' exposure to sanctions risk do feel free to reach out via our website or any of our social media channels.