International sanctions and cryptos: how to mitigate the risk

7 February 2020

Blockchain technology underpins digital currencies like Bitcoin and has the potential to alter the global financial system over the next couple of years. In particular, trade finance. This area of the financial system is most likely to benefit from the technology as it can help it become cheaper, faster and more accessible to the wider market. However, businesses should be mindful of the emergence of international sanctions and the significant penalties that are attached to it in the event of a breach.

How does Blockchain help trade finance transactions?

Trade finance was first invented by the Italian merchants of the Renaissance and remains a cornerstone of the global economy today.

The only issue is that it’s costly, cumbersome and slow. Paper contracts are manually created, reviewed, amended and exchanged, which can take weeks for exporters to receive payments for their goods.

Blockchain technology addresses these issues by digitising the process, making it more transparent, cost-effective and accessible. Using digitised ledgers of title and assists with execution and settlement means there’s no lengthy human intervention causing a bottleneck in the process. Users can receive real-time updates and more transparent visibility on the transaction. The automated settlement mechanism eliminates intermediaries, reduces transaction costs and streamlines the cash cycle.

The impact of international sanctions on cryptocurrency and finance

International sanctions laws and regulations are imposed by governments and organisations to restrict doing business with certain entities, users, governments, countries or territories, industry sectors, trading activities or entities in general. Sanctions can include things like comprehensive trade embargoes or specific targeted measures designed to restrict business with specified groups or individuals. The prevention of sanctions breaches and contrasting the financing of terrorism are high-profile compliance requirements for all cryptofirms.

If you don’t take appropriate steps to comply, your business could face hefty fines or penalties.

In November 2018, the United States Treasury’s Office of Foreign Assets Control (OFAC) discovered two specific bitcoin addresses belonging to sanctioned Iranian money launderers.

Since this first listing of its kind, the cryptocurrency industry has been put under greater scrutiny by sanctioning bodies to limit the ability of them to facilitate global and national security threats.

The OFAC acted on these findings by adding these two Bitcoin addresses to its list of Specially Designated Nationals (SDNs). With Russia, Iran, North Korea and Venezuela looking more and more likely to use cryptocurrencies to engage in these types of illicit activities and avoid international financial restrictions, further sanctions within the industry are inevitable.

Over the past couple of years, reports have revealed that Russia has used cryptocurrencies to engage in espionage, North Korea has engaged in cryptocurrency, enabled cybercrime to raise funds, while Venezuela launched its own digital currency to facilitate sanctions evasion. In light of this, cryptocurrency businesses have to be prepared for tougher sanctions and compliance. The art of being prepared is essential.

To ensure your crypto business takes a proactive approach and continues to flourish, online transactions monitoring tools are of primary importance.

Key international and local sanctions bodies and regimes

The list of sanctions bodies and regimes is quite long. At the international level, the United Nations (UN) sanctions must be first of all mentioned. The UN publishes and keeps updated the names of individuals and organisations subject to UN financial sanctions in relation to involvement with terrorist activities.

All UN member states must freeze the funds of any legal person(s) named in such lists and report any suspected name matches to the authorities. Further, the UN has in place other sanction lists that must be taken into considerations.

The EU applies sanctions, or other restrictive measures within the objectives of the Common Foreign and Security Policy (CFSP) set out in the Treaty of the European Union. The aforementioned Office of Foreign Assets Control (OFAC) of the US Department of the Treasury enforces economic and trade sanctions to target foreign countries/regimes, terrorist organisations, international narcotics traffickers, entities related to the proliferation of weapons of mass destructions and other threats to the national security of the US.

In this respect, it must be noted that the use of the US dollar automatically engages OFAC regulations. US prosecutors and courts are of the opinion that each financial transaction in USD is cleared in New York. Hence the US has jurisdiction over the offence. At a local level, each country may establish its own domestic sanctions regimes. Crypto-firms are required to identify and comply with such sanctions obligations. In the UK, for example, the Foreign and Commonwealth Office (FCO) is responsible for the overall policy of sanctions, while the HM Treasury supervises the implementation and administration of international financial sanctions in the country. Since March 2016, the Office of Financial Sanctions Implementation (OFSI) ensures that financial sanctions are properly understood, implemented and enforced in the UK.

In the US, the USA PATRIOT Act (Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism) contains provisions that financial institutions must comply with to deny terrorist organisations access to the financial system. As already mentioned, this act has worldwide implications when a transaction is carried out in USD.

Further, the US Treasury Financial Crimes Enforcement Network (FinCEN) enforces the so-called Special Measures, which restrict the access of these persons to the US financial system.

Finally, the Countering America’s Adversaries Through Sanctions Act (2017) imposes sanctions on Iran, North Korea and Russia.

THE KEY STEPS TO MITIGATE THE RISKS OUTLINED BY INTERNATIONAL SANCTIONS

As a starting point, incorporate sanctions screening technologies so that the information on the blockchain ledgers can be screened for any sanctions issues. Deploying online transaction monitoring solutions will give you a head-start on removing the risks. Your business will be able to examine blockchain data to see which users engaged in transactions over the past couple of years.

To comply with the international sanctions regime, your online transaction monitoring solution needs to be able to recognise users who adhere to it and those who are redflagged. All types of transactions need to be included and placed under the strict eye of your online transaction monitoring solution. The next thing to think about is managing your country risk exposure.

Are you able to identify the subtle signs of international sanctions risks? Your staff must be trained to recognise these red flags and have a knowledge of your country risk exposure too.

Here are a few key red flags you and your employees should be looking out for:

  • When a customer attempts to log-on to an exchange using IP addresses, email addresses, phone numbers or other identifying indicators registered in a sanctioned jurisdiction.
  • A customer is associated with endorsing cryptocurrency brokerage activity on P2P trading sites available to users in sanctioned jurisdictions.
  • A customer engages in indirect transactions with exchanges located in sanctioned jurisdictions, which cannot be explained.
  • A customer sends funds to a wallet that is a part of a “cluster” of addresses registered with a black-listed address, even if it hasn’t been identified as a black-listed address.
  • A customer makes frequent transactions through entities in countries associated with sanctions evasion activity without a clear answer as to why.

Once a red flag has been identified, your business is required to have documented investigative procedures and recordkeeping policies in place to find out more.

Leveraging network analysis and case management tools is another vital part of the investigative strategy. What are your internal escalation processes for raising alerts?

Is there a clear way of documenting your findings so that you can easily report back to regulatory bodies, law enforcement and other relevant stakeholders?

Finally, applying a comprehensive sanctions compliance risk management framework will streamline the process and keep your business on the right path. From conducting a sanctions risk assessment to measure your business’ overall level of risk exposure to designing the staff training and work processes to successfully mitigate the risk.

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