From the Ruble tanking by over 30 per cent, to being shut out of the international payment gateway SWIFT, sanctions from the West over Russia’s invasion of Ukraine have been hitting Moscow hard.
The impact of these sanctions are visible: the Russian currency has dipped over 30 per cent in the last few days, the central bank has had to suspend the execution of all orders by foreigners to sell securities indefinitely, a looming shortage of most consumer goods, and a worsening of terms of trade on future imports.
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In 2014, the Obama administration had brought about sanctions barring Americans from doing business with Russian banks, oil and gas developers, and other companies after the country’s invasion of Crimea. Economists estimated that the sanctions had cost Russia $50 billion a year, but that was at a time when digital currencies were not quite popular. Since then, cryptocurrencies and other digital assets have grown manifold, which is definitely bad news for those enforcing these sanctions.
How do sanctions work?
To understand how digital currencies and assets may play a role in helping Russia evade some of the sanctions imposed on them, we need to first understand how these sanctions work.
The US and European Union sanctions rely heavily on banks to enforce the rules. If a sanctioned business or individual wants to make a transaction denominated in traditional currencies, such as the US Dollar or Euro, it is the bank’s responsibility to flag and block those transactions. To apply sanctions, a government makes a list of people and businesses its citizens must avoid. Anyone caught engaging with a member of the list faces heavy fines.
But the real key to any effective sanctions programme is the global financial system. Banks around the world play a major role in enforcement. How? They see where money comes from and where it’s being sent, and anti-money laundering laws require them to block transactions with sanctioned entities and report what they see to authorities.
Can cryptocurrencies help go past these sanctions?
Now, this is exactly where cryptocurrencies come in. Digital currencies operate outside the realm of standard global banking, with transactions recorded on a public ledger known as the blockchain. Banks are bound to follow the “know your customer” rules, which include verifying their clients’ identities. But exchanges and other platforms that facilitate the buying and selling of cryptocurrencies and digital assets are rarely as good at tracking their customers as banks are, even though they are supposed to follow the same rules. In October, the US Treasury Department warned that cryptocurrencies posed an increasingly serious threat to the American sanctions programme and authorities needed to educate themselves about the technology.
There are currently more than 1,500 cryptocurrencies in existence, with a combined value of more than $320 billion, according to CoinMarketCap.com. By far the biggest of them is Bitcoin, which accounts for over 40% of their total value. But new cryptocurrencies can be created and sold without involving the banks and regulators that normally police currency markets. That is partly what makes them attractive to people under sanctions.
As a measure of trading without touching the dollar, which, according to experts, would be a great way to evade these sanctions, the Russian government is already developing its own central bank digital currency, a so-called Digital Ruble that it hopes to use to trade directly with other countries willing to accept it without first converting it into dollars. In October 2020, representatives of Russia’s central bank told a Moscow newspaper that the new Digital Ruble would make the country less dependent on the United States and better able to resist sanctions. It would let Russian entities conduct transactions outside the international banking system with any country willing to trade in digital currency.
Also, at the centre of this lies ransomware attacks, with Russia being the hub of this industry. Last year, about 74 per cent of global ransomware revenue, or more than $400 million worth of cryptocurrency, went to entities that are probably affiliated with Russia in some way, according to a report by the blockchain-tracking firm Chainalysis.
Websites used for illicit trades known as darknet markets brought in a record $1.7 billion worth of cryptocurrency in 2020, most of it in Bitcoin. And nearly all of the growth in the darknet market that year can be attributed to one specific Russian-language-only market called Hydra. Hydra is “by far the largest darknet market in the world, accounting for over 75% of darknet market revenue worldwide in 2020,” Chainalysis wrote in the report.
Despite the blockchain ledger that should help track the digital transactions, the technology behind Hydra is masking the source of transactions, offering a potential tool for Russian users to move money outside the country’s borders. On its own, Hydra is not big enough yet to handle the volume of transactions that Russia would need to successfully evade sanctions. However, other money-laundering techniques — including nesting, in which an illicit marketplace buries itself within a larger, legitimate structure to hide its activities — could also help, the report informed.
Is there a precedent?
Iran, North Korea, Venezuela. Russian may find friends in these countries when it comes to trading in digital currencies as they, too, have been hit by sanctions brought about by the US. China, Russia’s largest trading partner in both imports and exports according to the World Bank, has already launched its own central bank digital currency and the country’s leader Xi Jinping had recently described Beijing’s relationship with Moscow as having “no limits”.
In early February, independent sanctions monitors told the United Nations Security Council that North Korea was using cryptocurrencies to fund its nuclear and ballistic missile programme, according to Reuters. A spokesman for Norway’s permanent mission to the UN confirmed the existence of the report, which has not yet been made public.
Similarly, Iran, too, has been using digital currencies to, if not go past, mitigate the impact of the US sanctions. Like Russia, Iran is an oil-exporting country, and it remains under a decades-old near-total economic embargo by America, including bans on all imports and sanctions on Iranian financial institutions. However, according to consulting firm Elliptic, what Iran has done with its surplus energy that it can’t export is turn to bitcoin mining. Mining consumes a lot of electricity and with the pariah state not being able to export much, it has been taking some bite out of the sanctions by minting cryptocurrencies. Elliptic estimates that Iran-based miners account for approximately 4.5% of all Bitcoin mining, which would translate to annualised revenue of close to $1 billion.
Venezuela, however, is a more direct example of what Russia can do with digital assets. An investigation by the TIME magazine has revealed how the Putin regime used their Latin American ally to run their experiment of mitigating the effect of sanctions via cryptocurrencies. The value of the Venezuelan currency, the Bolivar, had been decimated by official mismanagement and the impact of US sanctions, which were imposed to punish President Nicolas Maduro for his deepening authoritarianism. Not only were Venezuelans helped develop the Petro, the cryptocurrency launched by the Venezuelan government, their experiment with the digital asset is being closely monitored by Moscow. Maduro hopes to raise as much as $6 billion and experts have warned that a lot of it could go toward propping up his regime and enriching his allies.