The Breakdown - Enforcing Sanctions in Crypto Isn't the Problem

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io, Arculus, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Friday, March 4th, and today we are discussing why enforcing sanctions in crypto isn't the problem. First up, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to get deeper into the conversation, come join us on the Breakers Discord. You can find the link of the show notes or go to bit.combe slash breakdown pod. Also, a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. Finally, this week, I'm thrilled to welcome another sponsor in Cointelli. This time of year, everyone's mind is on taxes. Cointelli is here to make crypto tax reporting stress-free for both individuals and accountants. Designed by CPAs, CoinTellie supports hundreds of crypto platforms and provides accurate calculations so you don't pay any extra on your taxes.

Starting point is 00:01:15 Cointelli also charges no added fees for up to 100,000 transactions and offers 24-7 customer support from tax advisors. Check them out at coineteli.com. That's coin T-E-L-L-I.com. and I want to say thanks again to CoinTellie for sponsoring the show and for helping people in what can be an extremely stressful moment. All right. So today we are going to be talking about three things that happened this week and why they together paint a perfect picture of the current state of the discourse on decentralization, sanctions, and crypto. The first thing is the Treasury Department's issue of the 2022 national risk assessments for money laundering, terrorist financing, and proliferation financing. This is the third iteration of this report and the newest since 2018. That means it's the first since the 2020 crypto bull run.

Starting point is 00:02:07 This report, quote, takes into account changes to the illicit finance risk environment resulting from the COVID-19 pandemic, ransomware, domestic violent extremism, corruption, the increased digitization of payments and financial services, and the enactment of significant new requirements to the U.S. anti-money laundering, countering the finance of terrorism, ML CFTC framework. The NRAs are an important resource that the public and private sectors can use to understand the current illicit finance environment and inform their own risk mitigation strategies, end quote. Like I said, this is the first of this type of report since crypto has been such a hot button issue among regulators, so let's look at some choice highlights

Starting point is 00:02:43 and see what they had to say about the crypto space and its ability to get around these types of regulations. The terrorist financing risk assessment says, quote, while terrorist use of virtual assets has become more prominent, the vast majority of terrorist funds raised in the United States still move through banks and money transmitters or are in cash. Okay? What about money laundering? Well, the money laundering risk assessment says, quote, the use of virtual assets for money laundering remains far below that of fiat currency and more traditional methods. Interesting. And so it's clear that a bit-pointer didn't write this, right? It was just the Treasury Department. Yes, indeed, that is the case. Mud 2 Monarch sums up, quote, Treasury's report confirms what we all know from

Starting point is 00:03:25 our common experience in industry research. Illicit use of crypto is a tiny fraction of Bitcoin and crypto's overall use for storing wealth, for politically neutral payments for trading and commerce. There is a lot more in the report. Our government is knowledgeable and informed about the state of affairs, and you should read the whole thing. But these are some damn good takeaways that confirm what we have been saying for so long. Still, this report is very general, right? And what everyone has been up in arms about and thinking about this week has to do with the current situation with Russia

Starting point is 00:03:52 and whether crypto can be used to evade sanctions. So let's see if the Treasury Department and the people in charge of sanctions have said anything about that. Hannah Lang, a fintech reporter at Reuters, writes on Wednesday at a webinar this morning, the National Security Council's Director of Cybersecurity, Carol House, says the scale that Russia would need to circumvent all financial sanctions, quote, would almost certainly render cryptocurrency as an ineffective primary tool for the state. However, we do remain vigilant against this threat and against the use of this vehicle as a means for evading sanctions. So here we have an acknowledgement that, yes, of course, they could theoretically use crypto,

Starting point is 00:04:28 but the scale at which they have to operate makes it kind of ineffective. This was echoed in a piece by the think tank Atlantic Council called Here's Why Crypto won't save the Kremlin from sanctions. This piece goes point by point over the New York Times piece from earlier in the week regarding crypto as a tool for evading sanctions and just kind of pokes holes in all of it. If you'll remember, one of the things that that piece focused on was the potential that Russia could use a digital ruble, a CBDC, to get around some of the sanctions. One, the article from the Atlantic Council points out, Russia doesn't have a digital rubble

Starting point is 00:05:01 program in any meaningful way, and it takes a really long time to build. But two, as they point out, quote, internationally, it is unclear why any nation would want large sums of digital rubles on its balance sheet anytime soon. Questions also remain about how widely accepted a digital ruble would be within Russia, particularly since it would experience much of the same volatility and counterparty limitations as the regular ruble and face of sanctions. You'll note, I'm not even making the point that a digital ruble is not crypto. It's just built on some of the same set of rails. It is just different Russian money.

Starting point is 00:05:31 But here we are. What about Bitcoin? Well, the piece says, quote, some members of Congress have suggested that privately issued cryptocurrencies such as Bitcoin could serve as a shelter for sizable Russian assets going forward. Again, that's unlikely. Contrary to popular belief, American companies offering cryptocurrency exchange services already must comply with U.S. law.

Starting point is 00:05:49 including foreign asset restrictions and anti-money laundering programs. Larger companies have heavyweight in-house lawyers who have spent years as federal prosecutors and take these compliance issues very seriously. Okay, so sounds like that's out as well. But what about the companies that aren't complying? Back to the Atlantic Council piece. Quote, even logistically speaking, it would be difficult to try to use cryptocurrency to sidestep sanctions at scale.

Starting point is 00:06:12 A fact, the U.S. National Security Council's Director for Cybersecurity confirmed this morning. For one, the U.S. Justice Department and Internal Revenue Service to say nothing of the intelligence community, are increasingly skilled at tracing complex transactions on public blockchains. Additionally, the Bank of Russia would need vast amounts of cryptocurrency, around $400 billion to counteract sanctions that target its foreign reserves. That's larger than the total market cap of all but two cryptocurrencies, and in the case of Bitcoin, would require massive purchases which would likely lead to price spikes making evasion more and more expensive.

Starting point is 00:06:44 And then, of course, and we'll wrap here with this piece, there's the problem of the politics of Bitcoin and crypto in Russia. Quote, politically, Moscow's attitude towards decentralized cryptocurrency has been mixed precisely because the Kremlin cannot control it. Jake Chervinsky, who's at the Blockchain Association and has been hot on the heels of this issue, writing even a 21 tweet thread on why crypto can't and won't be used to evade sanctions rights. There are three types of people.

Starting point is 00:07:11 Those who know crypto can't be used effectively for sanctions evasion in Russia. Those who claim it can because they hate it so much they want any excuse for regulation. Those who claim it can because they love it so much, they can't accept that it has limits. So this is thing one that happened this week. The actual officials in charge of sanctions, while keeping a close eye on crypto, do not view crypto in its current form as a truly viable way for nation-state-level actors like Russia to avoid those sanctions. Nexo is the go-to platform for all things crypto.

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Starting point is 00:09:12 FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCX, you pay no gas fees. Download the FTCX app today and use referral code breakdown to support the show. That brings us to point two, and of course it's a letter from Elizabeth Warren to the Treasury Department, co-signed by Sherrod Brown, Mark Warner, and Jack Reed. The letter concludes to ensure that economic sanctions remain an effective tool for achieving our foreign policy goals. We ask that Treasury provide information on how it tends to enforce OFAC's sanctions compliance guidance for the cryptocurrency community and inhibit the use of

Starting point is 00:09:51 cryptocurrency for sanctions evasions no later than March 23rd, including providing answers to the following questions. One, how does OFAC work with foreign governments and other participants in the international banking community to ensure that cryptocurrency is not used to evade sanctions? Two, what are the challenges OFAC has faced in applying the October guidance? Three, of all sanctions violations documented by OFAC in the virtual currency industry, what percentage of them were self-disclosed? Four, how has the growth of defy arrangements and services affected malign actors' ability

Starting point is 00:10:19 to circumvent sanctions as well as OFAC's ability to enforce sanctions? Five, what additional tools including legal authorities or funding might be necessary for OFAC to ensure that cryptocurrency participants are not able to help Russia or other malign actors evade U.S. and multilateral sanctions. The letter can be summed up by this one line. We are concerned that OFAC has not developed sufficiently strong and effective procedures for enforcement in the cryptocurrency industry. I would just at this point like to point out that the Treasury Department is hardly a shill for crypto. This is the group, after all, that was the most responsible for the broker provision in the infrastructure bill that caused such a dust-up

Starting point is 00:10:56 last summer. Yet this week, we have our elected representatives beating this horse, even while Treasury is saying this is not a top concern. Ryan Selkis, the founder at Masari, tweets Treasury, crypto isn't being used to evade sanctions. The exchanges are complying with OFAC requirements. Warren and her merry men of the Senate, we demand tighter regulations of crypto to address the problem you just said doesn't exist. Look, trying to be objective for a second, what this letter is actually asking for, which is ultimately a report on whether OFAC needs to be. better tools is fine. It's just hard to see this as a question that's being asked in good faith. This letter is a political document first and a policy document a distant second. There are a lot

Starting point is 00:11:40 of very real problems in the world, and my point is that we don't have time for the made-up ones. But this gets us to Section 3, and this idea of compliance. Joseph Politano, a financial management analyst at the Bureau of Labor Statistics, writes, the major crypto companies and exchanges are complying with the sanctions against Russia, but it's a radical shift in the crypto world. The modern crypto economy has so many intermediaries that the U.S. government can effectively regulate large chunks of the system. Lots of crypto actors have been choosing scale over decentralization over the last few years because scale is critical to a functioning and profitable financial firm. But enough scale means you're regulatable, and so now governments are able to

Starting point is 00:12:18 influence the crypto economy. The major crypto firms have similar anti-money laundering and know your customer rules as major traditional financial institutions, and the more these companies make themselves critical parts of the crypto economy, the more sway regulators will have over a quote-unquote decentralized system. Indeed, the point of crypto people have been making this entire week is not that crypto actors are not complying with sanctions. It's that they are complying with sanctions in ways that they maybe don't like. Yesterday, all the chatter was around OpenC, Metamask, and Inferra. Borsanar.eath tweets yesterday morning, not a GM at all. woke up to my OpenC trading account being deactivated slash deleted without notice or any explanation,

Starting point is 00:12:57 hearing lots of similar reports from other Iranian artists and collectors. What the hell is going on? Is OpenC straight up purging its users based on their country now? There were tons and tons of posts like this. I mean, it was all over Twitter. And it wasn't just OpenC. It was also users of Metamask in Venezuela. About 12 hours after the post started, OpenC tweeted, We are truly sorry to the artists and creators that are impacted, but OpenC is subject to strict policies around sanctions law, or a U.S.-based company and comply with U.S. sanctions law,

Starting point is 00:13:26 meaning we're required to block people in places on the U.S. sanctions list from using OpenC. If anyone thinks this enforcement happened to their accounts in error, they can reach out to support at OpenC.io. A representative of OpenC also told CoinDesk in a statement, quote, OpenC blocks users and territories on the U.S. sanctions list from using our services, including buying, selling, or transferring NFTs on OpenC. If we find individuals to be in violation of our sanctions policy, we take swift action to ban

Starting point is 00:13:52 the associated accounts. Like I said, this was also something similar happening on Metamask, and after a bit of confusion, a statement was issued that it was actually about Inferra, which is a blockchain node infrastructure that is used by Metamask alongside a huge portion of the Ethereum ecosystem. In Fuhra said, in response to the concerns we have been hearing, we want everyone to know that we corrected the problem that so many of you have pointed out. In changing some configurations as a result of the new sanctions directives from the United States and other jurisdictions, we mistakenly configured the settings more broadly than they needed to be.

Starting point is 00:14:22 This was our oversight, and we are grateful that this was pointed out to us. Once we determined what happened, we were able to fix the problem and service has been restored. We sincerely apologize for the interruption to those in inadvertently impacted regions. Metamaskan and Furra also did a joint blog post saying metamask and infura are unavailable in certain jurisdictions due to legal compliance. Host of up only, Kobe said that even after the clarification, it didn't really matter. Quote, infura being able to misconfigure and thus censor metamask payments in an entire geographic region is still very bad. It doesn't matter that this was a mistake. It matters that it is possible.

Starting point is 00:14:58 Larry Sermak from the bloc said if Metamask slash infura is open and willing to block countries like Venezuela by IP address, it's only a matter of time until they are forced by regulators to censor individual people's IP addresses. We need alternatives immediately. Jake Chervinsky responded to that and said, I don't necessarily disagree with the call to action here, but note that, quote, open and willing may not be the best way to describe, quote, required as a matter of law. As we consider how to develop market structure, we should assume people are going to follow what the law requires. And this is the real thing here. Consensus, who makes Metamask and Infura, key even default pieces of Ethereum infrastructure, is a U.S. domiciled company that has to follow these restrictions.

Starting point is 00:15:39 Autism Capital had some harsh words saying, if you're still larping about censorship resistance and using Ethereum, we hate to tell you, but it's time to give it up. Everything will be KYC, wallets are compromised, and you're already chain al-a-sist. Welcome to the new financial system, same as the old financial system. Ironically, this is where Bitcoin shines like the Maxis have been shouting since day one.

Starting point is 00:15:57 Its only job is to survive. It's not trying to be a financial system. It's trying to exist. A rock that just rocks. an annoying cancer that Ethereum centralist can't stand, the defiant. Now, to me, I think this is less something to take a victory lap about, but a moment for sure to consider the tradeoffs one is willing to make in their system. It's a moment for those who have been ignoring the clear centralized points of failure in the Ethereum and other potential ecosystems to reflect on whether those are

Starting point is 00:16:25 the types of tradeoffs that they're willing to make. Ethereum has spent the last years moving to try to compete with Bitcoin on store value, sound money properties. This is the whole ultra-sound money meme around EIP 1559 and a deflationary currency. The episode that we've seen this week makes clear that it cannot compete with Bitcoin when it comes to censorship resistance, at least certainly not now as the ecosystem is currently organized. Now, there are many people in the Web3 space who care deeply about these problems, and I would be quite surprised not to see them try to address it. But for now, the great irony of this week is that as Elizabeth Warren and the anti-crypto lobby crow about sanctions evasion, in reality, the community, is discovering that decentralized services are even more centralized than they seemed. I want to say thanks again to my sponsors, nexo.io, Arculus, FTX, and Coyntelli.

Starting point is 00:17:13 And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - Enforcing Sanctions in Crypto Isn't the Problem

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