The Latest Russian Sanctions Evasion Scheme

Increased Use of Cryptocurrencies

Image by WorldSpectrum from Pixabay

Russia’s Duma last week passed legislation that will authorize the use of international payments via cryptocurrencies. The lower house of Parliament greenlighted the new bill, and the senate and President Putin are expected to quickly pass it. Russia’s central bank governor, Elvira Nabiullina, last week confirmed that crypto-based payments would begin taking place before the end of the year.

This is interesting news coming out of Russia and a stunning reversal from the central bank, considering that it proposed banning cryptocurrency transactions in the country and the mining of digital assets just two years ago. Moscow has argued for years that digital assets could be used in money laundering or to finance terrorism, claimed that cryptocurrencies were just to volatile to allow (and too difficult to control), and banned their use as payment for domestic transactions.

So what happened?

Sanctions happened. First, some of Russia’s biggest banks have been sanctioned and cut off from the global financial system. Then some of them were kicked out of SWIFT - the Society for Worldwide Interbank Telecommunication that facilitates the smooth transfer of funds across borders - harming their ability to conduct global transactions. Then, came Executive Order (EO) 14114, which authorized the US Office of Foreign Assets Control (OFAC) to impose secondary sanctions on foreign financial institutions that support and facilitate transactions for Russia’s military-industrial sector.

And then came the big hit. The US Treasury assessed that any entity designated pursuant to EO 14024—imposing sanctions on entities engaged in Russian harmful activities—is now part of Russia’s military-industrial sector, since Russia has completed its pivot to a wartime economy. Therefore, any financial institution engaging with significant transactions with any of the several thousand individuals and entities sanctioned under EO 14024, can now face US secondary sanctions.

And let’s not forget the thousands uppon thousands of companies considered to be “shadow” entities that are not specifically included on the SDN list, but are 50 percent or more owned by a designated entity!

The effect of the threat was immediate. EO 14114 was signed in late December, and no one has been sanctioned pursuant to this authority yet. But the thousands of individuals and entities sanctioned pursuant to EO 14024 now carry a note that they present a secondary sanctions risk.

• The Bank of China’s Russian subsidiary in June tightened controls and suspended operations with Russian lenders sanctioned by the United States to avoid secondary sanctions risk. The Kommersant newspaper reported (link in Russian) that the bank, whose settlement business focuses on yuan payments between Russia and China, is suspending operations with Russian banks on the US SDN List. According to experts, Bank of China accounts for a significant portion of payment traffic, although it is now increasingly shifting toward non-bank intermediaries.

• Russia in May admitted that sanctions on Russia and enhanced pressure on countries that Moscow considers friendly are hurting Russian firms' export revenues and creating oil payment issues.

• Experts last month warned that Chinese and Indian banks could lose access to US dollar and correspondent banking services.

• Raiffeisen, one of the largest western banks still operating in Russia, in June suspended all outgoing payments in US dollars from the country, following warnings that it could be “shut out” of the US financial system.

• In a report last month, the Bank of Russia disclosed that it had to double its offer of yuan liquidity under swap operations as a surge in demand following the end of dollar and euro swaps caused rates to spike to 31 percent, according to Bloomberg.

• Last week, Kommersant reported (link in Russian) that roughly 80 of bank transfers made in Chinese yuan are bouncing back. Direct transfers between Russia and China are becoming increasingly difficult, so clients have to resort to the services of intermediaries and include additional commissions in transactions.

You get the idea. Secondary sanctions are wreaking havoc with Russia’s ability to engage in international trade, and something had to be done. The central bank admitted that payment delays have led to an 8 percent decline in Russian imports in the second quarter of 2024.

And despite Russia's efforts to switch to the currencies of its trade partners and develop an alternative payment system within the BRICS group of emerging economies, many payments are still conducted in dollars and euros and go through the international SWIFT system.

Enter the new crypto law.

Under this new legislation, Russia’s central bank will create a new "experimental" infrastructure for cryptocurrency payments. No details have yet been announced, but given Russia’s shoddy record creating and maintaining infrastructure in pretty much every other sphere, I’d advise caution.

According to Anatoly Aksakov, head of the Duma’s financial market committee, the pivot to cryptocurrencies could help Russia bypass western sanctions. And on a smaller scale, this has already been happening.

• The Wall Street Journal in April reported that a self-described Russian smuggler in China was using the Tether stablecoin to facilitate transactions between Russia’s largest maker of small arms, US-designated Kalashnikov Concern and a Hong Kong electronics distributor.

• Chinese digital platform Qifa has helped ease cross-border settlement challenges between Russia and China, because some settlements directly through banks are taking months to clear due to sanctions concerns. Qifa this year launched bilateral trade and has turned to digital asset and cryptocurrency settlements that can happen in a single day to facilitate trade with Russia. Qifa is already facilitating cross-border payments using tether.

There’s not enough liquidity in the crypto sphere to facilitate large-scale evasion. Russia is, after all, one of the largest economies in the world. That said, Russia is now racing to legalize the mining of digital assets and help cross-border transactions, so the legislation may help the Kremlin to make up at least some lost revenues.

In addition, Russia—as always—will violate law and gain access to anything it needs using ethically and legally questionable means. Russian hackers in 2022 developed new tools that could hide information from the blockchain, masking the origins of transactions to allow businesses to trade with Russian entities without detection, according to the Center for Strategic and International Studies, citing the New York Times. Should aliases and transfer logs disappear from the blockchain, authorities would no longer be able to trace Russian companies trading with the regime and flows of cryptocurrencies to Russia.

These techniques apply especially to noncustodial wallets. Whereas CASPs require users’ ex ante identification, noncustodial wallets only communicate via payers’ encrypted aliases. For example, after Russia’s invasion of Ukraine, CASPs like Coinbase and Binance blocked the wallets of Russian individuals under U.S. sanctions. However, noncustodial wallets remained “beyond the reach of the authorities.”

Yes, Russia can use digital assets to evade sanctions, although circumventing them on a large scale is much more difficult. OFAC in March noted that “Russia is increasingly turning to alternative payment mechanisms to circumvent U.S. sanctions and continue to fund its war against Ukraine,” citing Undersecretary for Terrorism and Financial Intelligence, Brian Nelson. In an effort to prevent sanctions evasion using digital assets, Treasury proceeded to designate companies that have all either helped build or operate blockchain-based services for, or enabled virtual currency payments in, the Russian financial sector, thus enabling potential sanctions evasion.

I would expect that Treasury will continue targeting any novel ways Russia develops to evade sanctions and designating any companies that help Russia’s war economy by facilitating transactions using cryptocurrencies. The challenge is the ever-changing landscape. Malign actors always find ways to evade detection, and regulators are always playing catch-up.

But the good news is that the rushed passage of this new law and the problems Russia is having with cross-border payments indicates that sanctions are still an effective tool.

I would predict that Qifa is in the crosshairs. I’m not a lawyer, but if a company is facilitating cross-border payments between Russian companies and China, I would think it can be considered a foreign financial institution. I guess we shall see.