With Decentralized Finance and Sanctions Come Crypto Regulation


It had to happen. The cryptocurrency template has been copied. After all, if an alternative to money can be bought and traded independently of central banks, why can’t financial instruments be bought and traded independently of brokerage houses as well? That is the idea behind what is euphemistically called decentralized finance or DeFi.

Let’s say that, for whatever reason, you want to acquire, exchange and store cryptocurrencies without having to participate in an exchange. Or deposit your cryptocurrency while earning interest. Either borrow or lend on a peer-to-peer basis. Or join others in a philanthropic endeavor to support a good cause? Or even to take out an insurance policy. All of that and more is possible with DeFi, which for a variety of technical reasons operates on the Ethereum network.

And it is popular. According DeFi Pulse, the total value of DeFi applications exceeded $107 billion as of the end of November 2021. The surge prompted critics, including prominent politicians, to warn consumers of a lack of regulation. Just as crypto was meant to function in its own ecosystem free of government regulation, so too was DeFi. Since anyone with an internet connection can take advantage of DeFi at any time of any day, it’s certainly convenient, but the lack of regulation is an open invitation for experienced crypto scammers.

Why DeFi is a challenge for governments

However, cryptocurrencies and DeFi present numerous opportunities for abuse. They have been used to enable fraud, tax evasion, money laundering, and the transfer of funds to criminal enterprises and even terrorist organizations. Until now, tackling blockchain-enabled crimes like these has been the top, if not the only, priority for governments, regulators, financial institutions, and law enforcement agencies. The Financial Action Task Force, or FATF, an intergovernmental forum founded in 1989 at the initiative of the G7 to develop policies to combat money laundering, has taken the lead in mobilizing the international community to address this problem. But a different challenge has arisen.

The sanctions imposed on Russia following its invasion of Ukraine have focused attention on the ways in which blockchain can be used as a tool to circumvent them. Certainly, from the Russian perspective, there are many good reasons to do so. As a result of the sanctions, the value of the ruble initially sank by 30%, prices of imported goods skyrocketed in tandem, and the Bank of Russia, whose access to its foreign exchange reserves in the West was frozen, raised its rate preferential interest. to a staggering 20% ​​overnight. There is also widespread concern that Russia will start defaulting on loans to Western banks this spring if sanctions continue.

Meanwhile, Visa, Mastercard and American Express have stopped providing services to Russian banks, which have also been disconnected from SWIFT. PayPal has also stopped serving Russian consumers. Therefore, there are few, if any, options for Russian consumers to pay foreign merchants, except for the minority of them who hold cryptocurrencies. Their number increased immediately after the sanctions were imposed when large numbers of ordinary Russian citizens withdrew rubles from their banks and used them to buy cryptocurrencies as a hedge against overnight deflation of their currency.

And now they can move it, lend it, invest it and much more using DeFi. For obvious reasons, there is great concern in the West that blockchain, and specifically DeFi, is being used to mute the effect of sanctions and keep the country’s economy afloat. That understanding has awakened the international community in general, and the West in particular, to the fact that cryptocurrency issuers and exchanges that are not formally registered in any specific jurisdiction can easily circumvent sanction requirements because it is difficult for any government to go after them. .

The ability of a government to impose actions against locally domiciled companies that do business with individuals, companies and governments restricted by financial sanctions or FATF enforcement leaves a huge loophole for countries like Russia to exploit. Virtually all FATF members are Western democracies. But if it seeks to issue recommendations designed to bridge the gap, it will face opposition from Russia, which is also a member.

Then what will happen? For Western democracies, a logical response would be to require all cryptocurrency exchanges and platforms operating within their borders to abide by their sanctions. But that requires a license, and license means regulation. That is why the Executive Order on Ensuring the Responsible Development of Digital Assets, issued March 9 is very timely. While most of the attention has focused on his proposal for a central bank digital currency, he lists a number of other “major policy objectives” with respect to digital assets, including, and not coincidentally, the following:

“We must mitigate the illicit finance and national security risks posed by the misuse of digital assets. Digital assets can pose significant illicit financial risks, including money laundering, cybercrime and ransomware, narcotics and human trafficking, and financing of terrorism and proliferation. Digital assets can also be used as a tool to circumvent US and other financial sanctions regimes and other tools and authorities. … The growth of decentralized financial ecosystems, peer-to-peer payment activity, and obscured blockchain ledgers without controls to mitigate illicit finance could also present additional market and national security risks in the future.”

The executive order further requires the attorney general, in consultation with the secretary of the Treasury and the chairman of the Federal Reserve, to provide within 210 days a legislative proposal that would make its provisions into law. What that means is that the creation and institutionalization of a US government regulatory infrastructure that will control cryptocurrency and DeFi transactions is now less than a year away.

This article does not necessarily reflect the views of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or their owners.

Author Information

Michael B Cohen is co-founder and vice president of global operations at MyChargeBack. He is an expert in the field of complex dispute resolution.

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