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Cryptocurrencies enlisted in the sanctions war

Countries most affected by sanctions have been considering how cryptocurrencies may be used to reduce the financial impact of sanctions

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Published 14 May 2019

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The use of sanctions against Russia and Iran is not a new development in the fight to curb their respective rogue geopolitical initiatives, but sanction use has certainly been on the increase in the past two years. In response, those countries most affected by sanctions have been considering how cryptocurrencies may be used to reduce the financial impact of sanctions and this brings added risk to those doing business in those countries.

The US and the EU have adopted sanctions on Russia as a central part of their response to the political crisis in Ukraine. Congress also imposed sanctions on Russia in March 2018 as a result of US intelligence into Russia’s alleged role the 2016 Presidential elections and it faces further sanctions following the poisoning of former Russian spy, Sergei Skirpal, in Salisbury, earlier this year.

Iran is also currently subject to US sanctions and its economy is suffering as a result. In November 2018, it was removed from the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”) network. This has effectively excluded the Iranian Central Bank from doing business with the rest of the world and made it impossible for retail banks in Iran to conduct business with other countries. Only last week, President Trump signed an executive order imposing sanctions on Iran’s metal industry.

Economic impact

The sanctions imposed on Iran and Russia in 2018 resulted in many foreign companies announcing their intention to exit these markets and end new investment – companies were anxious to avoid losing access to the US market and the dollar-based global financial system.

As the world’s reserve currency, the US dollar is involved in almost every global transaction. Of particular concern to both Iran and Russia are the oil and gas industries, which are integral to both counties’ economies and which are traded in US dollars. Almost all dollar transactions are cleared through US or EU-based banks, which will block trades involving sanctioned entities meaning that they quickly become isolated – which is of course the purpose of the sanctions in the first place.

How to respond to the sanctions

One avenue which Russia and Iran are exploring to avoid US sanctions is the use of cryptocurrencies. Reports earlier in the year said that Russia is preparing a major investment in Bitcoin to replace the US dollar as a reserve currency in an attempt to tackle US sanctions. More recent reports also suggest that Russia and China are increasing their gold reserves in order to anchor their experiments with cryptocurrencies. New digital tokens would be entirely backed by gold reserves held in an international trust protecting it from state interference.

Similarly, Iran is believed to be developing a gold-backed cryptocurrency as an alternative payment method to combat its removal from SWIFT. Four Iranian banks have already launched their own digital token (PayMon) to settle payment transfers between themselves.

Implications on counterparties

The US and EU are not united over all sanctions imposed on Iran. Most notably, Germany, France and Britain have established their own trade channel to Iran following the US’s decision to withdraw from the 2015 Iran nuclear trade deal (although it has been announced that Iran is suspending some commitments to the 2015 deal; a move that the French Defence Minister has said would result in consequences and possibly sanctions). However, the volatility and lack of transparency of cryptocurrencies is unlikely to be an acceptable solution to EU countries to facilitate trade with Iran.

That being said, the US and EU are on common ground in respect of a number of sanctions and this has implications with businesses with current commercial interests in Russia and Iran. Whilst Russia and Iran may be looking to cryptocurrencies to avoid foreign sanctions, it is likely that businesses in the western world will be cautious. The markets for cryptocurrencies such as Bitcoin have been very turbulent over the last 12 months, but they remain available for trading by counterparties who wish to take advantage of their anonymity. However, the US dollar is still the dominant currency in the world financial system and accounts for more than 40 percent of global payments. Whilst the use of cryptocurrencies in Russia and Iran may allow for internal payments it will not give their citizens access to the international financial system which is anchored to the US dollar.

Companies must also be alive to the risk of facilitating a breach of international sanctions by dealing with sanctioned countries whether using cryptocurrencies or otherwise. The lack of transparency of cryptocurrencies means there is an added risk of not being sure who you are dealing with and a company could inadvertently facilitate the breach of a primary sanction and/or directly breach a secondary sanction (secondary sanctions target people who are doing business with sanctioned parties).

As sanctions continue to proliferate and are met with increasingly sophisticated counter-measures, businesses need to keep abreast of this growing and complex area to ensure they manage their risks effectively.

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Longer Reads

Cryptocurrencies enlisted in the sanctions war

Countries most affected by sanctions have been considering how cryptocurrencies may be used to reduce the financial impact of sanctions

Published 14 May 2019

Associated sectors / services

Authors

The use of sanctions against Russia and Iran is not a new development in the fight to curb their respective rogue geopolitical initiatives, but sanction use has certainly been on the increase in the past two years. In response, those countries most affected by sanctions have been considering how cryptocurrencies may be used to reduce the financial impact of sanctions and this brings added risk to those doing business in those countries.

The US and the EU have adopted sanctions on Russia as a central part of their response to the political crisis in Ukraine. Congress also imposed sanctions on Russia in March 2018 as a result of US intelligence into Russia’s alleged role the 2016 Presidential elections and it faces further sanctions following the poisoning of former Russian spy, Sergei Skirpal, in Salisbury, earlier this year.

Iran is also currently subject to US sanctions and its economy is suffering as a result. In November 2018, it was removed from the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”) network. This has effectively excluded the Iranian Central Bank from doing business with the rest of the world and made it impossible for retail banks in Iran to conduct business with other countries. Only last week, President Trump signed an executive order imposing sanctions on Iran’s metal industry.

Economic impact

The sanctions imposed on Iran and Russia in 2018 resulted in many foreign companies announcing their intention to exit these markets and end new investment – companies were anxious to avoid losing access to the US market and the dollar-based global financial system.

As the world’s reserve currency, the US dollar is involved in almost every global transaction. Of particular concern to both Iran and Russia are the oil and gas industries, which are integral to both counties’ economies and which are traded in US dollars. Almost all dollar transactions are cleared through US or EU-based banks, which will block trades involving sanctioned entities meaning that they quickly become isolated – which is of course the purpose of the sanctions in the first place.

How to respond to the sanctions

One avenue which Russia and Iran are exploring to avoid US sanctions is the use of cryptocurrencies. Reports earlier in the year said that Russia is preparing a major investment in Bitcoin to replace the US dollar as a reserve currency in an attempt to tackle US sanctions. More recent reports also suggest that Russia and China are increasing their gold reserves in order to anchor their experiments with cryptocurrencies. New digital tokens would be entirely backed by gold reserves held in an international trust protecting it from state interference.

Similarly, Iran is believed to be developing a gold-backed cryptocurrency as an alternative payment method to combat its removal from SWIFT. Four Iranian banks have already launched their own digital token (PayMon) to settle payment transfers between themselves.

Implications on counterparties

The US and EU are not united over all sanctions imposed on Iran. Most notably, Germany, France and Britain have established their own trade channel to Iran following the US’s decision to withdraw from the 2015 Iran nuclear trade deal (although it has been announced that Iran is suspending some commitments to the 2015 deal; a move that the French Defence Minister has said would result in consequences and possibly sanctions). However, the volatility and lack of transparency of cryptocurrencies is unlikely to be an acceptable solution to EU countries to facilitate trade with Iran.

That being said, the US and EU are on common ground in respect of a number of sanctions and this has implications with businesses with current commercial interests in Russia and Iran. Whilst Russia and Iran may be looking to cryptocurrencies to avoid foreign sanctions, it is likely that businesses in the western world will be cautious. The markets for cryptocurrencies such as Bitcoin have been very turbulent over the last 12 months, but they remain available for trading by counterparties who wish to take advantage of their anonymity. However, the US dollar is still the dominant currency in the world financial system and accounts for more than 40 percent of global payments. Whilst the use of cryptocurrencies in Russia and Iran may allow for internal payments it will not give their citizens access to the international financial system which is anchored to the US dollar.

Companies must also be alive to the risk of facilitating a breach of international sanctions by dealing with sanctioned countries whether using cryptocurrencies or otherwise. The lack of transparency of cryptocurrencies means there is an added risk of not being sure who you are dealing with and a company could inadvertently facilitate the breach of a primary sanction and/or directly breach a secondary sanction (secondary sanctions target people who are doing business with sanctioned parties).

As sanctions continue to proliferate and are met with increasingly sophisticated counter-measures, businesses need to keep abreast of this growing and complex area to ensure they manage their risks effectively.

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