Key Takeaways
- U.S. authorities rely on cryptocurrency exchanges and industry players to monitor sanctions compliance due to limited internal resources and expertise.
- The Office of Foreign Asset Control (OFAC) is increasingly incorporating crypto addresses into its designations, signaling an adaptation to digital assets.
- The U.S. government is actively working to increase its understanding of cryptocurrency but faces challenges keeping pace with rapid innovation.
- Current practices may inadvertently push crypto operations out of the U.S. and could alienate international partners who do not align with U.S. sanctions policies.
- Privacy coins pose a significant challenge to current tracking and monitoring efforts, potentially creating new avenues for illicit activity.
The U.S. Delegation of Sanctions Monitoring
The United States government, specifically the Office of Foreign Asset Control (OFAC) within the U.S. Treasury, is responsible for imposing sanctions on individuals and entities deemed threats to national security. However, when it comes to monitoring the use of digital assets for potentially illegal activities, U.S. authorities often find themselves facing limitations in both experience and resources. Consequently, this crucial task is frequently delegated to cryptocurrency exchanges and other industry participants.
OFAC has begun to incorporate cryptocurrency addresses into its sanctions designations. This was notably seen recently when two Chinese nationals accused of money laundering for North Korea’s Lazarus Group were added to the sanctions list, with their associated crypto addresses included. OFAC first introduced this practice in late 2018 when targeting two Iranian individuals for sanctions.
Jesse Spiro, head of policy at blockchain analytics firm Chainalysis, commented on this development. He highlighted that this action against individuals facilitating illicit activity for a previously sanctioned entity like Lazarus signals the Treasury’s advanced use of blockchain investigative techniques and a willingness to target those who enable illegal operations.
Adapting to Evolving Digital Assets
OFAC’s caution regarding cryptocurrency is understandable, given its potential use in countries under U.S. sanctions. North Korea’s extensive efforts in hacking exchanges, Venezuela’s creation of the oil-backed Petro, and Iran’s aspirations to develop a cryptocurrency immune to U.S. influence all contribute to a general suspicion among U.S. authorities toward the entire crypto industry.
Despite OFAC’s periodic designation of specific crypto wallets, their direct engagement with the crypto space and other U.S. government branches has been limited. Accustomed to traditional financial systems, regulators have struggled to adapt to the complexities of this new ecosystem.
Eric Lorber, Vice President at the Financial Integrity Network and Senior Director at the Foundation for Defense of Democracies, confirmed that the U.S. government has dedicated significant effort to understanding this area over the past couple of years, believing they now have a general grasp of the situation.
“There’s been a huge focus in the U.S. government on this in the last couple of years. There is a good sense that the U.S. government has a general sense of what’s going on.”
Jesse Spiro concurred that relevant financial regulators are actively engaged. He stated that the Treasury Department, including FinCEN, OFAC, and the Terrorism Financing and Financial Crimes (TFFC) policy office, is intensifying its work on cryptocurrency, identifying and targeting those who abuse the ecosystem.
“We also know that the Treasury Department — FinCEN, OFAC and even the policy office of TFFC (Terrorism Financing and Financial Crimes) — is actively ramping up their work on cryptocurrency and identifying and targeting potential bad actors that abuse the ecosystem.”
However, Yaya Fanusie, a former CIA counterterrorism analyst, expressed a less optimistic view. She described the increase in regulatory crypto-fluency as a slow burn, suggesting that there are likely challenges in getting up to speed with the technology.
The rapid pace of innovation within the cryptocurrency industry itself presents a significant hurdle. Tanvi Ratner, CEO of Policy 4.0, observed that while OFAC is well-equipped, their efforts are often outpaced by the industry’s advancements in masking transactions.
“They’re quite well equipped. There are only being beat by the rate of innovation in masking transactions.”
OFAC’s Reliance on Industry for Compliance
tradicionales y exigiendo que las instituciones financieras que operan en EE. UU. actúen como primera línea de defensa contra las violaciones de sanciones. OFAC tiene recursos limitados para rastrear activamente las transacciones por sí mismo.
Yaya Fanusie clarified that the government’s role isn’t solely focused on monitoring incoming and outgoing transactions. Instead, they depend on external entities like exchanges to flag suspicious activities and on investigative reporting.
“Maybe I can dispel a myth. It’s not so much that the government has to focus on what’s going in and out. You have to rely on others, you have to rely on exchanges flagging things, you have to rely on investigative reporters.”
Regulators have shown a unified stance in expecting businesses in the crypto space to implement anti-money laundering (AML) and countering the financing of terrorism (CFT) programs. While these measures are standard for traditional financial institutions, they often conflict with the inherent characteristics of cryptocurrency, such as transaction speed, borderless accessibility, and ease of transfer.
David Adesnik, Director of Research at the Foundation for Defense of Democracies, questioned whether existing statutes have adequately adapted to the digital asset landscape, suggesting that the Treasury is attempting to apply current laws to this new domain.
John Roth, head of compliance at the crypto exchange Bittrex, agreed that OFAC’s approach to crypto mirrors its approach to traditional fiat currency. OFAC designates entities or individuals, and then expects exchanges to have systems in place to prevent transactions with them. Roth noted that this process is fundamentally similar to how traditional banks operate.
“OFAC’s approach to crypto is pretty much the same as fiat. OFAC designates, but they expect exchanges to have programs in place to prevent transactions to/from prohibited persons/countries. It is really not that much different from a traditional bank.”
While Roth expressed positivity about OFAC’s openness, he acknowledged the unique challenges presented by cryptocurrency, stating that adapting traditional compliance requirements to the digital asset’s nature is the main challenge.
“I think the requirements are clear. The challenge is adapting those requirements to the unique nature of cryptocurrency.”
Bittrex’s history with OFAC is noteworthy. The exchange froze Iranian accounts for two years before receiving a license from OFAC in November. The specifics of how this dispute was resolved between OFAC and Bittrex remain undisclosed.
Blockchain analytics firms such as Chainalysis and Elliptic are frequently mentioned by experts in this field. Chainalysis, in particular, has become increasingly vital, collaborating with government agencies to investigate blockchain transactions for suspicious activities. The firm holds active contracts with the IRS, the Drug Enforcement Administration, and Immigration and Customs Enforcement, and has secured over $1.1 million in contracts with the FBI in recent months.
Even crypto-native companies rely on firms like Chainalysis to navigate regulatory obligations, despite government agencies being relative newcomers to the technology. Roth mentioned that U.S. exchanges universally utilize services like Chainalysis and Elliptic to scan blockchains for connections to sanctioned entities and implement internal controls.
“All of the US exchanges use the same services (Chainalysis and Elliptic) that scour the blockchain to look for links to those kinds of customers, and have other internal controls in place.”
The increasing compliance demands have led many crypto exchanges and related firms to partner with government-approved blockchain analytics firms. A Chainalysis representative explained the firm’s growth, citing regulatory compliance as a primary driver for new cryptocurrency exchange customers adopting their technology.
“We’ve increased our customer count by 290% over the past two years, and new cryptocurrency exchange customers cite regulatory compliance as a top reason for adopting our technology.”
Critiques of the Current Approach
The effectiveness of security measures is often only apparent when they prevent potential harms, making them seem like overreactions in retrospect. However, these safeguards might inadvertently penalize legitimate businesses while struggling to address the most sophisticated technical challenges. For instance, U.S. sanctions on Iran’s mining industry, while potentially inconvenient, may be beyond the Treasury’s technical enforcement capabilities.
A significant technical hurdle remains the issue of privacy coins, such as Monero (XMR) and Dash (DASH). Fanusie pointed out that tracing transactions on these privacy-focused cryptocurrencies remains a challenge for which no definitive solution has been found.
“I don’t think anyone has cracked that yet.”
Blockchain analytics firms have yet to develop software that can consistently trace transactions on privacy coins. The CEO of CipherTrace, a blockchain analytics firm, predicted that treating crypto financing similarly to traditional banking could lead users to adopt privacy-enhanced coins, further complicating OFAC’s oversight.
“As we get more of this deanonymization and it becomes more like banking, I think an unintended consequence will be that there will be concerted effort to use these privacy-enhanced coins.”
The increased regulatory scrutiny and expectations are impacting crypto exchanges financially. Representatives from Coinbase and Kraken have indicated that excessive scrutiny from regulators affects their profitability, emphasizing the costs associated with hiring additional legal staff and external compliance tools.
John Roth stated that a compliant crypto exchange requires a dedicated compliance department and the necessary third-party tools to avoid dealing with illicit actors. He described this as the price of admission for operating in the U.S. market.
“A compliant crypto exchange absolutely needs a dedicated compliance department, with the kinds of third-party tools necessary to ensure that they aren’t doing business with bad actors. This is the price of admission for doing business in the US, and most crypto companies understand that. If you don’t, I think the risks are significant.”
The expenses associated with staying current with OFAC’s evolving and often unclear requirements can be prohibitive for newer businesses, potentially forcing them to cease operations in the U.S. This has led to exchanges like Binance establishing more restricted U.S. operations (Binance.US) and Digitex eliminating KYC requirements after a data breach, with its CEO citing U.S. authorities’ demands as a detriment to user data protection.
While the U.S. is a major global economy, driving exchanges out of the country does not necessarily solve the problem of illicit crypto use. Bad actors can adapt and exploit regulatory arbitrage. The most vulnerable parties to these stringent expectations are exchanges striving for legal compliance.
Beyond immediate impacts on exchanges, these stringent measures limit U.S. access to crypto services. Overly aggressive sanctions could also encourage even U.S. allies to operate outside of U.S.-influenced economic systems, potentially hindering economic growth and the effectiveness of future sanctions.
Potential for Alienating the Global Economy
The implications of aggressive U.S. sanctions extend beyond the cryptocurrency sphere. A recent publication in The Economist warned that the U.S.’s extensive use of economic sanctions and warfare could prompt the international market to seek alternatives to the U.S. dollar.
In the case of Bittrex freezing Iranian accounts, the exchange took action out of fear of the OFAC, even though OFAC might not have had direct legal recourse to compel such a freeze. Eric Lorber pointed out that the U.S. government may lack the legal authority to block assets of individuals in foreign countries who are not specifically targeted by sanctions, even if they are involved in transactions with sanctioned entities.
Using exchanges to bypass legal restrictions may not foster goodwill among affected populations and could appear contrary to the principles of American capitalism.
Lorber further elaborated that OFAC’s influence abroad has limitations. He noted that a European financial institution might not have the legal basis to block funds from an Iranian national designated by OFAC if the funds are transferred to their institution.
Tanvi Ratna, who authored an article for Foreign Policy discussing Iran’s potential use of Bitcoin against U.S. sanctions, highlighted the challenges the U.S. faces in garnering international support for its sanctions policies. She emphasized that unilateral changes in stance by the U.S. may not be adopted by other nations, particularly those with different economic and political interests concerning Iran.
“The U.S. unilaterally changed stance and others don’t necessarily want to play along. You can’t impose sanctions unilaterally. Nor is everybody uninterested or threatened by Iran. Look at the attitudes of the Europeans, Chinese, Indians towards Iran.”
Cryptocurrency’s Role in Global Sanctions
Within the broader framework of OFAC sanctions, cryptocurrency represents a minor component. However, its dynamic nature, speed, and ability to transcend national borders make it a notable factor. Cryptocurrencies also present a challenge to established financial systems, such as SWIFT, which the U.S. has leveraged for political influence.
The coming years will be crucial in defining the U.S. Treasury’s relationship with cryptocurrency and its capacity to adapt to evolving global financial systems. OFAC’s response to cryptocurrency innovations will serve as an indicator of its priorities and willingness to embrace change.
Cointelegraph has made multiple attempts to contact OFAC for comment, but no response has been received. This article will be updated should further information become available.
Final Thoughts
The U.S. government is grappling with the complexities of cryptocurrency and sanctions enforcement, increasingly relying on industry players for monitoring capabilities. While efforts are being made to adapt, the rapid evolution of digital assets, particularly privacy coins, presents ongoing challenges.
The current approach of delegating monitoring and imposing stringent requirements may inadvertently push necessary crypto operations out of the country and could strain international economic relationships, potentially limiting the long-term effectiveness of U.S. sanctions policy.