Cryptocurrency could be a way for Russia to evade Ukraine sanctions, some fear

The use of bitcoin as a digital weapon in the Ukraine war will also go a long way in determining cryptocurrency’s future in the financial system. Some are calling for tighter regulations to crack down on its more shadowy uses by hackers and criminals while others push back on the notion that it’s being exploited by bad actors and point to how millions of dollars worth of cryptocurrency donations have flowed in to fund Ukraine’s war effort in recent days.

“Right now, millions of transactions are taking place that are completely unregulated with no one verifying who gets what,” Senator Elizabeth Warren of Massachusetts said at a hearing Thursday as she pressed Federal Reserve Chairman Jerome Powell for more cryptocurrency rules. “And that means that while sanctions can make it very difficult for Russian companies, political leaders, and billionaires to move money around in the traditional financial system, there is another shadow, unregulated world that they can turn to.”

Warren and three other Senate Democrats wrote to Treasury Secretary Janet Yellen on Wednesday raising those concerns. They pointed to instances in recent years of North Korea and Iran employing cryptocurrency to evade sanctions, as well as the flow of ransom payments in cryptocurrency to Russian hackers.

The Biden administration has been worried, too. A Treasury report last fall warned that cryptocurrency could be used to “reduce the efficacy of American sanctions” and a department official said Friday that they were monitoring the use of the digital currency by Russia.

But the administration downplayed the potential of crypto investments to allow Russia to significantly evade sanctions, like those that prevent its central bank, certain large companies, and oligarchs with ties to Russian President Vladimir Putin to access vast stores of dollars, euros, pounds, and yen held outside their country.

In effect, cryptocurrency is less a main avenue to evade sanctions than a back alley, according to administration officials and industry experts.

“Is crypto potentially part of their playbook? Certainly. … but frankly it isn’t at the top of their list,” Todd Conklin, counselor to the deputy treasury secretary, said of Russia’s efforts to get around sanctions during a webinar for industry representatives and reporters hosted by TRM Labs, a cryptocurrency analytics company.

Russia is one of the world’s largest economies, a member of the Group of 20 with an economic output in 2020 of about $1.4 trillion. The entire value of the world’s cryptocurrency market is about $1.8 trillion. The Russian government had built up its reserves of dollars and other currencies in recent years in preparation for sanctions, but it didn’t focus on cryptocurrency and doing so now would be difficult, Conklin said.

“You can’t flip the switch overnight and run a G20 economy on cryptocurrency,” Conklin said.

But the ultra-rich elites around Putin whom the United States has personally sanctioned may benefit more than the Russian government from the technology. “It still is concerning from a much more micro perspective in terms of attacking the assets of the oligarchs and the Putin inner circle,” Conklin said.

Digital currencies have also been used to help Ukrainians as they face invasion. An appeal from Ukraine’s official Twitter account for cryptocurrency donations shortly after Russia’s invasion has led to more than $56 million worth of bitcoin, ether, and other virtual assets pouring into the government and an organization supporting its military, according to analytics firm Elliptic.

The money might not have reached the country otherwise because Ukraine’s martial law declaration after the invasion limits conventional banking transactions to prevent the flow of money out of the country, and the fund-raising platform GoFundMe prohibits raising money for war efforts, like buying weapons.

Bitcoins and other cryptocurrencies have libertarian roots, and surged in popularity after the 2008 global financial crisis shook confidence in the banking system. They are created with randomly generated cryptographic puzzles that require massive amounts of computing power to solve, then reside on a public ledger called a blockchain that runs on a decentralized global network of computers.

It’s a stateless form of currency that offers freedom from banks and a shield of privacy over electronic transactions. But that shield extends only so far.

Major cryptocurrency exchanges are subject to US and international bank secrecy and anti-money-laundering rules. That makes it difficult to actually use the currency to buy things without leaving digital footprints for regulators or law enforcement to track, said Jim Harper, a nonresident senior fellow at the American Enterprise Institute and an expert on cryptocurrency and privacy.

“If you painstakingly transact so that you don’t leave any footprints that tie to your real world identity, you can maintain that privacy for a while. But it’s brittle,” he said. “You can do all these transactions and be careful, but if you do one to a regulated exchange then the whole thing comes crashing down, like taking a hammer to peanut brittle.”

Russians could try to operate completely away from regulated exchanges, but that would require a buyer to agree to make a major purchase, like an oligarch’s superyacht, off the books.

“It would be like trying to evade sanctions by trafficking in exotic animals,” Harper said.

Each cryptocurrency transaction is made up of pieces that exist permanently on the blockchain, making it possible, although difficult, to connect them to a particular person or entity, Harper said. Law enforcement officials have shown they can do it, as they did last year with the ransomware attack on the Colonial Pipeline in the Southeast United States.

The company reportedly paid a ransom of nearly $5 million worth of bitcoin to the hackers. But the FBI was able to recover $2.3 million of that bitcoin by tracking the transactions and then gaining access to a digital wallet used by Russian hackers. And in September, Treasury officials blacklisted Suex, a cryptocurrency exchange with Russian ties involved in processing ransomware transactions for hackers, effectively shutting it down.

“Governments seeking to enforce sanctions and disrupt their evasion can invest in blockchain analytics to get ahead of Russian efforts to obscure any sanctions-evading transactions,” said Salman Banaei, head of public policy in North America for Chainalysis, a blockchain data analysis firm.

Just like with conventional banks, cryptocurrency exchanges can put measures in place to identify transactions from Russian companies or people under sanctions of the Ukraine war, he said.

Leaders of the cryptocurrency industry said they are complying with sanctions and collect information on their customers as required by law. But they’ve declined a request from a top Ukrainian official to block all Russians from using their platforms.

“Freezing access to digital assets of citizens from an entire country does not necessarily punish those who are actually responsible and who may have already prepared for the possibility of blanket sanctions,” said a spokesperson for Kraken, a leading US-based bitcoin and cryptocurrency exchange.

The technology behind cryptocurrency could be a longer-term solution for Russia to evade sanctions by allowing it to deploy a digital version of the ruble so it could buy and sell products directly with other countries without using the dollar, which is the standard now for global trade. Russia’s central bank is starting a pilot program for such a digital currency, which the Federal Reserve and other central banks also are exploring.

For now, the US is closely monitoring to make sure Russians aren’t eluding sanctions via cryptocurrency in countries without strong anti-money-laundering regulation, said Carole House, director of cybersecurity and secure digital innovation for the White House National Security Council.

She agreed that Russia probably wouldn’t exploit cryptocurrency as the primary way of evading sanctions, but “it is part of a suite of options and something we need the cryptocurrency sector to guard against.” She told industry representatives and reporters on Friday that the Biden administration is depending on the players in the industry to detect and report such activity.

But Warren, who has been highly critical of the industry for what she believes is its destabilizing effect on the global financial system and other concerns, said the ability of countries like Russia to use cryptocurrency “to sanction-proof themselves” is another reason to enact tighter regulations.

“Cracking down on crypto is a critical piece of holding Russia accountable for its aggression,” she told Powell on Thursday. “We can’t fool around any longer. We need to get new crypto rules in place.”

Jim Puzzanghera can be reached at jim.puzzanghera@globe.com. Follow him on Twitter: @JimPuzzanghera.