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KYC: Combatting Russia’s crypto influence

February 12, 2024

On 30 August, the Treasury’s Office of Financial Sanctions Implementation updated their official guidance to include “cryptoassets” in sanctions designations on persons or entities.  Under the new rules, VASPs are now obliged to report suspected sanctions breaches to UK authorities immediately.  

The rule change comes amid concerns that cryptocurrencies are being used to circumvent sanctions in response to Russia’s invasion of Ukraine.  While the Treasury has provided no further detail on the underlying allegations, there is plenty of circumstantial evidence in the public domain to demonstrate Russia’s advanced relationship with cryptoassets, and the challenges the West faces in rooting out illicit activity.

Russia’s historical relationship with digital assets

Russia has a somewhat schizophrenic history with cryptocurrency.  In 2020, the state gave digital assets legal status.  But earlier this year, it proposed a ban on the use and mining of cryptocurrencies, citing threats to financial stability and citizens’ wellbeing.  It then rolled back on those restrictions less than a week later.  

The difficulty in pulling the trigger one way or the other may lie in strategic imperatives to use crypto as a weapon to skirt sanctions.  At present, there is little evidence that this is the case.  Or it may be because Russia’s relationship with crypto-assets is not only longstanding, but also multi-faceted and geographically widespread.

According to the Cambridge Bitcoin Electricity Consumption Index, Russia is the third largest country in the world for crypto mining.  At last count, almost 12 percent of Russians hold (or have held) cryptocurrency.  That is an adoption level above the US and far beyond the UK at around 4 percent.  

Research also suggests that at the time of the Russian invasion, there were more than 400 VASPs accepting roubles.  They are tied to hundreds of thousands of crypto-addresses, spanning several assets.  Many are likely to be unregulated entities, with minimal or no KYC requirements or AML checks.  These entities have facilitated the trade of hundreds of millions of dollars in crypto, across several jurisdictions and subsidiaries.  

Crypto-related sanctions on the increase

Some of these companies have come to light in recent months, due in large part to the US Office of Foreign Assets Control, which has enacted sanctions on several Russian or Russian-linked exchanges.  

These include Estonia-based Garantex Europe - which was accused of processing over $100 million of illicit funds and formally sanctioned in April 2022 - and Czech-incorporated SUEX OTC, an arm of Moscow-based exchange SUEX.  SUEX OTC was designated by OFAC in September 2021 for allegedly facilitating financial transactions for ransomware actors.

A third exchange, Chatex, was sanctioned in November 2021, also for supporting ransomware actors in connection with SUEX.  Entities designated in this instance included companies registered in Estonia, Latvia, and St Vincent and the Grenadines.

On 20 April 2022, for the first time ever, OFAC designated companies operating in Russia’s virtual currency mining industry.  Swiss-registered Bitriver AG, the holding company of virtual currency mining company Bitriver, as well as 10 of its Russia-based subsidiaries, were also added the SDN list.

These entities and individuals formed part of what OFAC termed a “global network” led by Russian oligarch Konstantin Malofeyev, designated by OFAC in 2014.  New entries on the SDN list included Malofeyev’s son Kirill Konstantinovich Malofeyev and several Russia-based companies owned by him and associated with cryptocurrency exchange Vladeks.

Russia’s influence over (or involvement in) the digital asset sector is seemingly sprawling.  The fear is that this leaves the wider industry potentially exposed to Russia using the asset as a sanctions busting measure.

Using compliance to push back on bad actors

In recent months, Coinbase has blocked more than 25,000 addresses it says are tied to Russians suspected of illicit activity.  Binance has also curbed in activity in Russia, banning those holding more than EUR 10,000 from making new deposits or trades.

Notably, these activities tie in with the drivers behind the UK Treasury’s updated guidance.  VASPs are being asked to review their KYC documentation and take action accordingly, often in tandem with (or led by) blockchain analytics - scrutinising wallet activity for signs of illicit or suspicious behaviour and blacklisting those users and addresses.

Key to this development has been the introduction of AML rules for the crypto space, bolstered more recently by the so-called travel rule - the requirement that VASPs disclose KYC data on transacting customers.

Efforts to enact restrictions on Russian use of crypto is where the travel rule will have its first big test.   It has a critical role in safeguarding crypto’s (slowly improving) standing.  Its implementation is still nascent, but Russia will prove a useful testing ground in demonstrating that crypto has effective and decisive compliance tools.  

It is also a chance for the industry to shed the perception as a venue dominated by bad actors and illicit dealings; and to reinforce the argument that blockchain presents genuine tools to fight financial crime.  

No pressure then.

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