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Taming the Dark Side of Cryptocurrency in the Global Financial System

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Trade and economic sanctions against erring entities depend on centralised financial institutions for implementation. The institutions are required by law to report their activities to regulators. But with regulators removed from cryptocurrency’s flow of transaction, observers note that virtual currencies’ features make them viable tools to evade sanctions; a big threat to global security. 

The Islamic Republic of Iran is the latest country sanctioned by international bodies and the United States, to publicly signal plans to explore cryptocurrency as a means of payment for import and export. Although the action looks on the surface like the adoption of innovative technology, observers describe it as desperation:

“No country with a choice really wants to use cryptocurrencies in its international trade flows because of the volatility of price and for very large transactions not always easy to get sufficient liquidity…,”said Martin Walker, Director for Banking and Finance at the Center for Evidence-Based Management. 

Years of sanctions by the United States over Iran’s nuclear ambition have caused the latter’s economy to continue on a downward trend since 2017. The country struggles to trade in the dollar-based international market and is unable to access billions of dollars of its money in different countries.

Before Iran, other countries under sanctions by the US for varying reasons – including North Korea, Venezuela and Russia – either used cryptocurrencies such as bitcoin or floated their own virtual currencies. Although cryptocurrencies are yet to be optimised to move the huge sums of money necessary to sustain the economy of countries, critics say there are concerns that virtual currencies may usher in a future of ineffective sanctions where entities are unmoved by embargoes.

“I have seen insufficient evidence to worry about this at this point, but it is the stated goal of many cryptocurrency advocates to destroy the current global system,” said Bennett Tomlin, Independent researcher and co-host of Crypto Critic’ Corner.

Irrespective of critics’ perception of cryptocurrency, supporters see it as disrupting traditional financial systems that subject institutions to cumbersome regulations. Indeed, unlike conventional payment systems where it takes at least three days for recipients in cross-border transactions to receive payment, a typical peer-to-peer cryptocurrency transaction is not restricted by geographical and regulatory bottlenecks as it takes less than 10 minutes to reach its destination. 

Data from Chainalysis revealed that Africa received $105.6 billion in cryptocurrency between July 2020 and June 2021. The report gives insight into why for many people around the world – especially in Africa, who are restricted from receiving money through online payment platforms including PayPal – see cryptocurrency as a game changer that helps them cope with exclusion from international finance. Cryptocurrencies have also found a use case in preserving the value of fiat currencies in countries where political and economic instability have battered their legal tenders. 

The intricacies of sanctions

Sanctions have been used by world bodies including the UN and the European Union to rein the excesses of entities. The United States, in a unilateral bid and sometimes as part of a multilateral effort to protect its interests and that of its allies, has slammed over 9,000 sanctions on individuals, companies and countries for actions including human rights violations, cybercrimes and other illegal behaviours. 

Washington, however, is now concerned that its embargoes face the risk of being futile as cryptocurrencies become more popular and widely accepted. It’s a myriad of predicaments for the world power that is gradually losing grip of its ability to monitor the global financial system through instruments including the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system given the threats by digital currencies. There is little the US and indeed any government can do to shut down cryptocurrency operations because it is powered by the blockchain, a decentralised technology that keeps immutable copies of transaction details on computers in different geographical locations.

Sanction evasion by entities is not the only dark side cryptocurrencies have. The same technology which makes cryptocurrency a revolutionary innovation for legal transactions for many people across the globe, has also attracted criminals who use it to get payment in ransomware attacks.

“These problems have been around for over a decade, they have just grown bigger and more obvious,” Walker told Arweave News.

Some advocates say that like fiat money which is also used for illegal purposes, cryptocurrency in itself has no control over how its holder uses it. While this may be true, virtual currency transaction’s trustless and permissionless nature suggests to many people that it cloaks its haphazardness behind codes.

Cryptocurrency exchanges maintain order?

The US, waking up to the threats the misuse of cryptocurrency pose to the effectiveness of its sanctions is talking tough and threatening actions. “…It is vital that virtual currency exchanges, peer-to-peer exchangers and other providers of digital currency services harden their networks against these illicit schemes,” Sigal Mandelker, undersecretary for Terrorism and Financial Intelligence said.   

In cryptocurrency’s chain of transaction, exchange and trade platforms scattered around the world play critical roles. Offering peer-to-peer and wallet hosting services, exchange platforms could play a major role in cooperating to stop suspicious transactions and assisting authorities’ effort to detect the identity of entities behind a cryptocurrency transaction that is being investigated, given that transactions of digital currencies are partially anonymous. 

In theory, the role cryptocurrency exchanges could play is clear, but in reality, it plays out differently and this could be because of the absence of uniformity in international licencing requirements and regulatory policies among cryptocurrency exchanges. This challenge could play down cryptocurrency exchanges’ responsibility to act to end the exploitation of cryptocurrency for illicit activities. 

 A review of leading exchanges found that while some operate in jurisdictions with strong regulations, only a part of the operations of others were covered by regulations and others operate in unregulated jurisdictions. 

“The exchange ecosystem consists of a mix of exchanges ‘onshore’ that are regulated in terms of ‘Know Your Customer’ (KYC) and Anti-Money Laundering but not as exchanges and ‘offshore’ exchanges where anything goes,” Walker said. “An exchange, particularly those in locations with negligible regulation, is great mechanisms for washing illicit crypto. The fact that you have the interconnected group of exchanges varying from the lightly regulated to the borderline criminal, with flows between can make a mockery of attempts at controlling them.” 

Tomlin believes that in addition to regulators being limited in their ability to perform oversight functions because of poor knowledge of the digital currency ecosystem, some cryptocurrency exchanges are not willing to comply with regulations in their jurisdictions.

“It is immediately obvious to any observer that the exchanges are failing,” said Tomlin who mentioned instances where some cryptocurrency exchanges flouted regulations.

In jurisdictions with weak regulations, cryptocurrency’s positive disruptive use cases could be an effective tool to destabilise international security. Regulations that preserve the unique features of digital currencies while ensuring criminals are not able to use it could be accepted by everyone on different sides of the debate.

“There are many people who want to simply invest in crypto with no illegal motives. However, creating a clean crypto market would essentially lead to creating two parallel worlds: The legitimized one where exchanges keep a clear record of where every crypto and dollar came from, all clients are KYCed (known) and exchanges only interact with similarly regulated exchanges versus a free-for-all world,” Walker said. 


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