Is the Ukraine war intensifying regulatory pressure on crypto firms?


Which side are you on? The war between Ukraine and Russia is forcing people to answer that question. For some in the crypto community, this can be uncomfortable because if an individual or project supports the West against Russia, it also means that they are in compliance with sanctions. This can be difficult to reconcile with the supposedly decentralized crypto/blockchain system and its claims to be borderless, censorship-free, and distributed.

Take OpenSea, the NFT marketplace, which is not really a decentralized project, but is often described as such. “OpenSea is a decentralized peer-to-peer marketplace for buying, selling, and trading rare digital goods,” according to CoinMarketCap, for example.

But, when OpenSea recently banned Iranian users from using its NFT trading platform, explaining that it was only in compliance with US sanctions law, sparked outrage among some NFT collectors. Documentary photographer Khashayar Sharifaee tweeted:

This raises questions: Are the public and government officials now more focused on crypto regulation, especially with the outbreak of the Russian-Ukrainian war? OpenSea angered many in its community by banning Iranian users, but did it have a choice?

Also, while large US-based crypto-related companies like FTX, Coinbase, OpenSea, and Consensys have to comply with US sanctions and regulations, what about decentralized projects without a US headquarters? easily identifiable leaders or national affiliation? Will they comply or can they too, or will they get a pass?

Finally, there is a longer-term question: Will we ever have a truly decentralized market? Won’t the cryptoverse inevitably have to compromise at least a little with centralized institutions like sovereign governments?

More regulatory attention

“Government authorities have definitely become more interested in crypto regulation in recent times,” Cory Klippsten, CEO of Swan.com, told Cointelegraph when asked about recent events, adding that serious regulatory discussions have been ongoing. for many years. “Still, the Russo-Ukrainian War has put cryptocurrencies in the spotlight, so we are seeing increased public interest in relation to these crypto regulatory developments.”

“Everyone is starting to rethink the importance of compliance and crypto for various reasons,” Carlos Domingo, founder and CEO of Securitize, agreed to Cointelegraph. “We are seeing live, right now, the importance and effectiveness of sanctions” in relation to the war.

US regulators are pressuring the biggest players in the crypto space to comply. “And now, also, somewhat decentralized crypto platforms,” Markus Hammer, a lawyer and director of consultancy Hammer Execution, told Cointelegraph. Perhaps that is why OpenSea was tough on Iranian users last week, even though Iranian sanctions were re-imposed in 2020.

“As regulations appear to be imminent, companies like OpenSea are trying to protect themselves by making sure they comply with potential regulations that are coming,” Klippsten said, adding, “this is why they are looking at banning the Iranians.” Cointelegraph sought comment from OpenSea for this story, but received no response.

Will one start to see more projects like Binance or FTX that were vague about their geographic homes become more clear about where they are based? will it be others to declarelike OpenSea last week: “Are we a US based company?” that it must “comply with US sanctions law?”

“I’m not sure OpenSea tried to hide their location,” Domingo replied. “Most people knew that the CEO and other employees were based in New York.” He also added, for the record, “I don’t see OpenSea as a decentralized project at all. I think it’s pretty centralized, similar to Coinbase, Binance and FTX.”

Rather, what we are seeing now is that “regulators are increasingly concerned about fraud and illegal activities committed against their citizens and businesses, and are increasingly willing to take enforcement action anywhere in the world, such as in the case of BitMEX,” said Domingo. .

Still, many in the crypto community see treachery in OpenSea’s actions: after all, blockchain-based projects are supposed to be free from censorship. Was it fair that an Iranian artist, who has nothing to do with his government’s action, is now denied a platform to sell his digital art?

“OpenSea has to comply with US regulations and sanctions laws just like any other US-based centralized company,” Klippsten said. “In contrast, a decentralized project like Bitcoin doesn’t have a leader and doesn’t really have permission. It is impossible to ban users or comply with sanctions when no one can unilaterally control the project.

It does not make things any easier that there are different types of sanctions regimes. The sanctions imposed by the US against Russia, for example, are targeted. That is, they do not apply to the majority of ordinary Russians, but to financial concerns and Russian elites, including the oligarchs. US Iranian sanctions, by contrast, affect all users based in Iran.

Russians in Yekaterinburg protest the invasion of Ukraine. Source: Vladislav Postnikov

The parties may also differ in their interpretations of sanctions. Iranian artist Arefeh Norouzii, who was “disarmed” by OpenSea, for example, while an Iranian citizen “isn’t even domiciled in Iran,” Hammer said. “In that case, he would argue that the legal basis for OpenSea’s decision to remove the platform from Arefeh based on its terms is not in line with the relevant sanctions.”

According to Domingo, “OpenSea would be committing a crime by processing transactions from people living in Iran, and it’s as simple as that,” adding:

“I know it seems unfair that people in sanctioned countries are affected in this way as they are not responsible for the actions of their governments, but this is what the US government has decided is best. way to protect its citizens and interests.

Is it fair to say, given recent events, that some entities are not as decentralized as they claim? “Some infrastructure services are more centralized than it seems at first glance,” Fabian Schär, a professor in the department of business and economics at the University of Basel, told Cointelegraph, although users have other options even if the projects are not fully decentralized. . “They can just run their own full node and use alternate user interfaces.”

According to Hammer, many of these “somewhat decentralized” platforms didn’t even think about financial market regulations until recently. “They believed in the supposedly safe ‘decentralized’ space and never considered that they might eventually get caught up in the market regulation of the traditional financial world.” However, it is now catching up with them, particularly crypto exchanges with fiat ramps, he added.

Will DEXes comply?

What about truly decentralized projects? Are they untouchable from a regulatory or compliance standpoint? Or, since there is now some very good compliance software to identify “bad actors” in decentralized digital ledgers, isn’t it possible for DEXs and other decentralized projects to comply if they really want to?

“The tools are out there and they’re getting stronger and more and more effective,” Hammer said. A good example is how Chainalysis’s forensic tools were used recently to identify the malefactor behind the notorious The DAO hack in 2016, he added.

“It is very easy for companies to comply with regulations if they wish to do so,” agreed Domingo. “There is no lack of tools or technology and, in fact, it seems that some ‘decentralized’ projects are already doing it”.

Software solutions exist, Schär said, “and any party that bridges traditional finance and decentralized finance must comply with anti-money laundering regulation and sanctions lists.” Since their entire business model depends on access to traditional payment systems, Schär does not believe that they will put this access at risk.

Rather, “decentralized exchanges are just smart contracts that provide a neutral infrastructure,” Schär continued. “A smart contract cannot execute these controls. However, we must also be aware that these decentralized exchanges do not have access to traditional finance. All you can do is exchange tokens.” As a result, the risks posed by DEXes are much lower than those posed by centralized exchanges, he said.

Of course, some entities will play regulatory arbitrage as long as they can, Domingo said. But this is a short-sighted strategy because “although technology moves faster than regulation, regulation eventually catches up.”

Overall, though, one big question remains: will we ever have a truly decentralized marketplace? “There are some truly decentralized markets,” Schär said. A non-updatable constant function market maker is an example, he explained:

“There are no special privileges, no external dependencies and no one in charge who can even make these decisions.”

Such projects are basically in operation forever: they cannot be directly regulated. For that reason, “lawmakers and regulators should focus on on-ramps and off-ramps and use indirect regulation,” Schär added. Although, according to Hammer, decentralization can be achieved as long as an organization follows two principles: it implements open source code, and it is governed by a decentralized autonomous organization, or DAO.

But, perhaps there will always be some constraints on behavior even among decentralized entities, and projects will inevitably have to engage with centralized institutions like sovereign governments.

“Yes, that’s how I see it,” Domingo said. “Finance will continue to become increasingly decentralized, but adoption will require safeguards to protect investors from scams and bad actors. Eventually we will come to some kind of middle ground.”