Three Key Takeaways from the U.S. Senate Banking Committee’s Hearing on How Crypto May Be Used in Financial Crime

On March 17, 2022, the U.S. Senate Banking Committee conducted a hearing titled “Understanding the Role of Digital Assets in Illicit Finance.” In the backdrop of Russia escalating its attacks against Ukraine, the Senate Banking Committee took a closer look at the role crypto is playing in the Russia-Ukraine conflict and the extent to which it is being used to evade sanctions.

The financial and crypto industry experts testifying in the Senate Banking Committee hearing included Michael Mosier, Former Acting Director, Deputy Director/Digital Innovation Officer, Financial Crimes Enforcement Network (FinCEN); Michael Chobanian, Founder of KUNA Exchange and President of Blockchain Association of Ukraine; Shane Stansbury, Duke University School of Law’s Robinson Everett Distinguished Fellow in the Center for Law, Ethics and National Security Senior Lecturing Fellow; and Jonathan Levin, Co-Founder and Chief Strategy Officer, Chainalysis, Inc.

While discussing crypto’s role in sanction evasion, the witnesses largely discredited the notion that crypto is being used as an escape route by oligarchs and other sanctioned entities to evade sanctions. The witnesses, instead, highlighted the positive impact made by crypto donations on Ukraine’s fundraising campaign. Michael Chobanian placed emphasis on the fact that crowdfunding in crypto can be more transparent, faster, and more cost-effective than donating conventional currencies when compared to other currencies such as the Dollar or Euro. “First problem that we're solving is urgency. So in order for us dollars to actually land on Ukrainian bank accounts, it takes at least one day if we are lucky but usually takes two days. Time is a vital thing. So for the crypto which works 24/7, we receive money instantly and we can spend money instantly,” explained Chobanian.

One thing that is clear from the hearing is that there has been a significant shift in terms of how regulators view cryptocurrencies. Supporting this viewpoint, Senator Pat Toomey (R-PA) stated that it is a “mischaracterization that crypto is the wild west of illicit finance.”

1. Senators exhibited a nuanced understanding of digital assets 

From the hearing, it is evident that lawmakers are proactively working towards attaining a better understanding of digital assets and their underlying technology. While some senators raised valid concerns regarding cryptocurrencies, they did not lose sight of the tremendous potential benefits it offers.

The Senators were also well-informed about the various obfuscating technologies that illicit actors use to hide the source and destination of funds. Senators Mark Warner (D-VA), Chris Van Hollen (D-MD), and Sherrod Brown (D-OH) asked whether sanctioned entities can use techniques such as coin mixing and chain hopping to hide the origin and destination of the funds

Senator Bill Hagerty (R-TN) also asked insightful questions regarding how crypto tracing can be done at an enterprise level. Senator Hagerty explained that in crypto transactions, though the transacting parties can transact between themselves without revealing their identities and involving intermediaries, there isn’t true anonymity. Being pseudo-anonymous, crypto transactions are visible and accessible on the public blockchain and can be traced by blockchain analytics companies. However, he noted that blockchain analytics companies can only identify the attached crypto wallet addresses and not the real-life identity of an entity. He asked the witnesses that “what capabilities exist that can actually track and identify illicit actors in the cryptocurrency transactions.”

2. Senator Elizabeth Warren introduced a new bill targeting non-compliant foreign exchanges

Senator Warren’s (D-MA) proposed bill, called the Digital Asset Sanctions Compliance Enhancement Act, targets sanctioned oligarchs who try to skirt sanctions by using foreign exchanges. Sanctioned entities can use non-compliant exchanges and peer-to-peer (P2P) exchanges situated in jurisdictions with weak AML/CFT controls as cash-out points. Senator Warren’s bill directly targets sanctioned individuals and entities instead of just focusing on wallets associated with them. This approach is more efficient as sanctioned entities can find ways to detach themselves from known addresses/sanctioned addresses by using devious tactics, such as creating multiple self-hosted wallets, to bypass the screening of transaction monitoring tools.

Merkle Science not only provides sanction screenings for wallet addresses that are tagged against sanctioned entities but also equips compliance officers to investigate both direct and indirect risks, such as those originating from associated addresses. Therefore, addresses interacting either directly or indirectly with the sanctioned addresses will be flagged as high-risk alerts on our transaction monitoring tools.

Some senators were concerned about the impact that Senator Warren’s bill might have on ordinary Russian Citizens. “I know the intent is to go after oligarchs, but it looks to me like it would have a hugely negative impact on anybody in Russia engaged in any kind of crypto transactions,” Senator Pat Toomey said.

Agreeing with Senator Toomey, Michael Chobanian warned that “U.S. lawmakers should use caution in making sure any new regulations don’t inadvertently further weaken Russians who have already been cut off from mainstream financial services.” He further added that, “we only have to go after the sanctioned list and sanctioned people. We have to make sure that we don’t block these people and we still allow for the opposition to survive both within Russia and outside because, as you know, they can’t use Visa, MasterCard cards outside of Russia right now. So, the only means of payments they have is cash or crypto.”

This concern arises from Section 4 of the bill, which gives the U.S. Department of Treasury the power to implement a full and indiscriminate ban on exchanges or non-custodial wallet providers doing business with “digital asset addresses that are known to be, or could reasonably be known to be, affiliated with persons headquartered or domiciled in the Russian Federation.”

3. Russia cannot use crypto on a broad scale to evade sanctions

When asked if Russia could use cryptocurrency to skirt sanctions, witnesses stated that it can not be used to evade sanctions on a large scale. Michael Chobanian stated that “I'm the person who is behind all the numbers. I know how it happens. So it's physically impossible to transfer large amounts of money from fiat into crypto.” Michael Mosier noted that “I will quote my successor as counselor to the Deputy Secretary of Treasury who recently said you can't flip a switch overnight and run a G20 country on cryptocurrency — there just isn't the liquidity.”

Though it is true that coin mixing services can offer anonymity to the sanction evaders by breaking the link between customers’ transaction logs and their identities, these tools are slow and expensive to use, especially, when the sanctioned actors are trying to move around hundreds of millions of dollars. 

Sanctioned entities can skirt sanctions using cross-chain swapping smart contracts on decentralized finance (DeFi) protocols. These smart contracts allow users to exchange cryptocurrencies from different blockchains in a single transaction. Sanctioned entities can also go to unlicensed over-the-counter trading platforms to cash out cryptocurrencies. However, even these techniques cannot be used to evade sanctions on a large scale as these platforms will most likely not have the required trading volume or assets on hand.

Some senators were also worried that Russia may use cryptocurrency mining to evade sanctions. “Because the main costs associated with mining cryptocurrency is energy, I worry that the Russian government will also look to mining as a way to evade sanctions,” observed Senator Bob Menendez. Citing the Cambridge bitcoin electricity consumption index, he added that Russia accounts for 13.6% of bitcoin mining. However, it is unlikely that crypto mining will generate enough revenue to replace regular business activity in sanctioned nations.”