Why cryptocurrencies will not solve Russia’s sanctions problem

Not only can cryptocurrency fund flows be tracked, their decentralised nature makes the large-scale transactions needed to evade sanctions unfeasible
A central bank digital currency could offer an alternative, but Russia’s digital rouble lacks the scale required, and China is very unlikely to allow the digital yuan to be used for this purpose

Hugh Harsono

Published: 1:30am, 17 Mar 2022

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Russia’s invasion of Ukraine has resulted in an escalating flurry of responses from governments, regulators and international financial institutions alike. These actions included economic sanctions and the removal of Russian banks from the Swift global payment system.

This has led to the rouble sliding in value and the Russian central bank raising its key interest rate. As a result, there is increasing interest in and concern over the potential use of cryptocurrencies by Russian threat actors to evade sanctions.

There have been calls to ban Russian accounts on cryptocurrency exchanges, though this would have little effect in deterring large-scale Russian threat actors from accessing various financial resources. Rather, it is a central bank digital currency, rather than decentralised cryptocurrencies, that could enable Russian entities to evade enterprise-level sanctions.

On the face of it, cryptocurrencies seem like a potent tool for sanctions evasion due to their immutability, liquidity and pseudo-anonymous nature. However, these factors also work against cryptocurrencies being used by large companies to evade sanctions, as the distributed ledger technology that underpins them enables the tracking of fund flows.

Additionally, cryptocurrencies’ decentralised nature makes large-scale transactions with a view to evading sanctions unfeasible. Cryptocurrency transactions happen fastest through exchanges, which facilitate the conversion of fiat currency into cryptocurrency and vice versa.

However, most exchanges capable of handling big transaction volumes comply with local and international anti-money-laundering and know-your-customer regulations, thus preventing Russian or any other threat actors from using cryptocurrencies specifically to get around sanctions.

This is not to say that evading sanctions via cryptocurrencies is impossible. In fact, it is extremely probable that smaller Russian organisations and individuals have already used cryptocurrencies to do so on a smaller scale. There have been reports of Russian capital flight through cryptocurrency mediums to countries on the Financial Action Task Force designation’s “grey list”.

Additionally, specific cryptocurrencies with built-in privacy features, and tools such as cryptocurrency tumblers, which help conceal currency origins, could help facilitate these types of transactions, allowing smaller threat actors to launder existing cryptocurrency holdings.

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The power of the American dollar has made tools like sanctions extremely effective from a Western perspective. However, Russia has been attempting to reduce its reliance on the dollar, though these efforts have been hampered by the fact the dollar is the currency of choice for international transactions.

Russia launched a trial of its digital rouble in mid-February, with at least two banks completing transfers of the digital currency between Russian citizens.

The centrally-controlled nature of the digital rouble could allow it to be used regardless of whether it complies with current financial intermediaries like the Swift system or even China’s Cross-Border Interbank Payments System (CIPS).

Additionally, the digital nature of the currency could help the Central Bank of Russia better control interest rates, thereby potentially mitigating the effects of events like the current cash run in Russia.

If fully scaled up, a digital rouble could help Russia evade Western sanctions on large companies, which would dent their impact.

However, the fact the digital rouble is still in the trial phase makes it unlikely that it could have any effect in sanctions avoidance, particularly from a cross-border and wholesale perspective. Only when a central bank digital currency has achieved widespread usage could it be suitable for such purposes, in theory at least.

A man walks past a currency exchange office in central Moscow on February 28, the day the Russian rouble collapsed against the dollar and the euro on the Moscow Stock Exchange as the West punished Moscow with harsh new sanctions over the invasion of Ukraine. Photo: AFP

Although China and Russia have maintained friendly relations, it is unlikely that either China’s CIPS system or the digital yuan could be used to aid Russia. CIPS currently reaches less than 80 members and handles a fraction of the transactions that Swift does.

However, the digital yuan is one example of a central bank digital currency that could achieve the economies of scale needed to support such actions, with its successful initial roll-out and tests in both wholesale – that is, payments between banks and financial markets – and retail environments.

However, there is no indication that China intends to help Russian threat actors circumvent sanctions. Doing so could result in a domino effect of creating sanctions on Chinese entities, which would affect digital yuan usage, something the Chinese government would wish to avoid.

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Cryptocurrencies do trouble government officials, particularly because their pseudo-anonymous nature creates the perception that they are able to bypass anti-money-laundering regulations.

However, the sheer scale required to help Russian entities is too large for most cryptocurrency exchanges to handle. So, while cryptocurrencies may be a way for smaller threat actors or less dynamic economies like North Korea to evade sanctions, it would not be feasible in the case of an economy of Russia’s size.

Moreover, while a scaled-up central bank digital currency would in theory be one way for Russia to get round Western sanctions, the digital rouble pilot scheme is simply not up to the task, which requires high levels of liquidity, cross-border transactions and compliance with any number of international financial intermediaries, to name but a few factors.

Hugh Harsono writes regularly for multiple publications about cyberspace, economics, foreign affairs and technology