Cryptocurrencies and sanctions


The Venezuelan government is desperate to raise hard currency to pay for imports and service its debts to foreigners. Its latest gambit is a cryptocurrency called the “petro”. People could start buying petros on February 20 in a pre-sale. President Nicolás Maduro claimed that these purchases raised $735 million in the first few hours. More money may come in on March 20 in what would be the largest Initial Coin Offering (ICO) to date.

This matters for banks, lawyers, investors, clients and other parties seeking to avoid breaching US and EU economic sanctions. President Maduro has made no secret of his intention to use the petro explicitly to circumvent US sanctions. They must pay close attention to the fact that cryptocurrencies are not immune to sanctions exposure and need to understand how to manage this risk.

President Trump’s Executive Order No. 13808 prohibits any US person from purchasing or dealing with any “new debt” issued by Venezuela with a maturity of more than 30 days. “New debt” is defined broadly by the US Treasury Department’s Office of Foreign Assets Control (OFAC) — the main enforcer of US sanctions — to include “extensions of credit”. According to OFAC, the petro “would appear to be an extension of credit” and US persons dealing with it “may be exposed to US sanctions risk”.

The EU and the US have placed broad prohibitions on dealings and transactions with persons and companies mentioned on so-called sanctions lists. These prohibitions are often enforced with the help of regulated financial institutions. Traditionally, centralised intermediaries — usually banks — stand between the two parties to any transaction. These intermediaries are supposed to have systems to detect whether any designated persons or sanctioned activities are involved.

Most cryptocurrencies, including the petro, do not operate within this paradigm. Bitcoin and other tokens were invented in part to circumvent the existing regulated financial system. Instead of a centralised record of transactions there is a decentralised public ledger. The identities of transacting parties are concealed and only a digital key is needed to make a transaction. Officials fear that cryptocurrencies will facilitate transactions that contravene sanctions.

However, the idea that cryptocurrency transactions can easily avoid sanctions needs to be taken with a pinch of salt — at least for cryptocurrencies explicitly backed by governments, such as the petro. The issuance of a cryptocurrency by, say, a central bank will by definition have some centralised currency characteristics and so might be more easily detectable, following more predictable exchange flows than typical decentralized cryptocurrency transactions. It may only be a question of time before regulators notice red flags that, in turn, trigger investigations of cryptocurrency transactions.

So, in which contexts can dealing with a cryptocurrency generate sanctions exposure for companies and individuals?

A few include the following:

  • Anonymous cryptocurrency exchanges. Because of the anonymity afforded by many cryptocurrencies, companies using them risk inadvertently dealing with a designated person and, ultimately, assisting prohibited activities.
  • Cryptocurrency investors. Investors in ICOs may find themselves subject to potential liabilities because of an ICO that violates sanctions.
  • Crowdfunding. Companies involved in crowdfunding might receive payments in a cryptocurrency from sanctioned individuals or companies and, in return, end up offering them a stake in their company, albeit unintentionally.
  • Law firms. A number of lawyers and law firms are accepting payment using cryptocurrencies. This is extremely risky given the professional obligations placed on the legal profession.

There is currently no comprehensive regulation of cryptocurrencies. This is not surprising, given the fast pace of development. However, banks are taking some measures that limit the use of cryptocurrencies. In January 2018, for example, Nordea Bank AB stated that all its employees were prohibited from dealing in cryptocurrencies. Lloyds Bank has banned the purchase of Bitcoins and other cryptocurrencies using credit cards. The European Banking Authority has warned about the risks of virtual currencies.

There is a steady trend towards more regulation. The US Treasury Department has issued calls for countries to intensify oversight of cryptocurrencies. In Japan and Australia, cryptocurrencies are already regulated. As for the European Union, moves towards developing cryptocurrency regulation are in motion. The European Banking Authority has indicated it will bring virtual currencies within the scope of existing anti-money laundering (AML) and anti-terrorist financing rules.

A more concentrated focus on uncovering sanctions violations through use of cryptocurrencies could spur lawmakers and regulators in the world’s major economies and financial centers to demand more transparency in the form of details of transactions, including parties involved, to be disclosed. This would bring to a head the tensions between anonymity and transparency.

So what can companies do to avoid sanctions exposure?

Just because involvement with designated persons and sanctioned activities might be more difficult to detect in the cryptocurrency world, this does not let companies off the hook. Direct violation of sanctions, or assisting others in avoiding sanctions, can lead to large financial or criminal penalties. Ignorance of who you are dealing with is a limited defense.

One challenge facing many companies is how existing screening procedures can be used – or revised – to accommodate cryptocurrency transactions.

Know Your Customer/Counter-party (KYC). The use of KYC and AML procedures in the cryptocurrency Spielraum is gaining appetite. Some commentators insist that KYC procedures can, or should, be employed to know the actual identity of a counter-party, even though identities in cryptocurrency transactions are encrypted. Accordingly, the disclosed identity of the counter-party must match the latter’s encrypted key. The U.S. Securities and Exchange Commission (SEC) Chairman, Jay Clayton, has also highlighted that KYC and AML procedures must not be undermined by dealers and brokers when allowing cryptocurrencies to be purchased by customers.

Know Your Transaction (KYT). Due diligence can be performed to better understand the nature of the transaction and business involved and, by doing so, help avoid engaging – directly or indirectly – in sanctioned activities. Coupled with that, contractual safeguards may be placed to ensure that payments by cryptocurrency will only be employed for the intended use and not directed towards any designated party or sanctioned activity.

Last December, the SEC provided a list of sample questions to guide investors before investing in cryptocurrency or an ICO. These straddle the KYC and KYT frameworks.

Just like a government-backed cryptocurrency runs counter to a key tenet of crypto-currencies — no government control — the KYC avenue, specifically, challenges another tenet: anonymity. It’s not yet clear how many of cryptocurrency’s initial features will be adjusted to become more palatable for governments and banks.

What is likely, however, is that how the US Treasury deals with the Venezuelan petro-saga is likely to set an example for the market and potentially deter other countries from seeking to establish their own cryptocurrencies.

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