Sanctions: Dwindling Effectiveness in the Crypto Era

Welcome to RDC Insider Insights. This monthly series covers a multitude of modern-day financial crimes. We’ve analyzed our global datasets to understand how certain types of crimes and risks are changing over time, both globally and in regional splits, to uncover trends and provide insights.

The effectiveness of sanctions has been exhaustively debated and some experts predict their power to enforce peace and security is diminishing. Calls from humanitarian organizations to lift trade restrictions due to coronavirus underscore the negative externalities of comprehensive sanctions on societies in crisis, while growing popularity of cryptocurrency reveals the increasing plausibility of sanctions evasion. In light of such nuances, Financial Institutions need to understand how to manage the increasing risks of operating with a sanctioned entity.

Intentionally hindering national economies.

Sanctions are meant to restrict the trading power of individuals or organizations that are violating human rights, trade agreements, etc. Some sanctions are more impactful than others, yet their benefits are questionable. Sanctions targeting specific kleptocrat networks, or rulers and associates who compromise their political status by stealing state resources, have been successful in maintaining stability among governments as well as the general public’s relative access to basic needs, such as in South Sudan.

On the other hand, comprehensive sanctions imposed on Venezuela in 2019 are projected to compound the ongoing humanitarian crisis, while the government continues to adapt to new markets under these same restrictions. Since action was taken against Venezuela in 2015, there has been a correlated increase in reported humanitarian crimes, business crimes, terrorism, money laundering and bribery, alongside staggering rates of death, starvation, unemployment and inflation. These conditions are predicted to worsen under the expanded restrictions, targeting state-owned oil company Petróleos de Venezuela, S.A. (PDVSA), as well as gold, food, banking and mining industries.

Multi-sectoral suffocation of Venezuela’s industry has dire consequences for its population short-term; however, Iran has proven that domestic markets can adapt and ultimately develop greater economic success by persisting despite such limitations. Iran has dealt with varying degrees of sanctions since 1979, the year the US placed its first sanction on Iran. Fast-forward to 2020, past hundreds of EU, UN, and US sanctions—and even one Nuclear Trade Deal — Iran is yet again in the spotlight of international sanctions. Nevertheless, Iran’s economy has continued to function, albeit with high inflation and unemployment. Due to Iran’s complex and historical relationship with different sanctions programs, the country has developed alternative markets to fall back on during times of crisis. One of the most impactful has been the blockchain technology industry.

Sanctions Evasion via Crypto Development

In Iran, as a result of high inflation and lack of demand for exports, Iranian citizens created a crypto market so that the average person could work within the state’s economy and still earn a living. Widespread use of cryptocurrencies influenced the national legalization of bitcoin mining. By diversifying both its economy and currency, Iran has been able to overcome the humanitarian crises seen there in the late 1990’s and early 2000’s.

Similar to Iran, Venezuelan citizens have responded to hyperinflation by mining cryptocurrency to trade for US dollars. This is the most stable means of securing a living, but it’s not without risk for citizens. The National Superintendency of Crypto Assets and Related Activities (Sunacrip) is the government body regulating the first-ever national cryptocurrency, the ‘Petromodena’ or ‘Petro’, and any unapproved mining operations are illegal. Through this regulation, the government has been able to collect bitcoin taxes.

The Petro has received criticism as it defeats the decentralized purpose of crypto and devalues the Bolivar hard currency—each share is backed by a barrel of oil that is unexchangeable. Venezuela’s military-backed president, Maduro, however, uses the currency to exchange for bitcoin and evade the watchful eye of US banks and regulators. At the request of PDVSA, Banco Central de Venezuela was planning to stockpile bitcoin within the Internal Reserve System—evidence that PDVSA has been receiving crypto-income parallel to sanctions complying markets.

Crypto: The unpredictability for compliance

Implementation of cryptocurrency markets has increased sanctions compliance risks. These markets incentivize countries with similar restrictions to interact, proving that adapting to sanctions is not purely domestic but rather an international effort of parallel market globalization.

2020 High Risk Sanctions Nations

The above map illustrates the countries considered to be high-risk for sanctions compliance programs, and most are known to operate in cooperation. Russia, for example, has accepted barrels of oil as debt repayment from Venezuela. Moreover, China offered medical aid to deal with coronavirus to Venezuela.

Venezuela and Iran have engaged in a parallel economy of trade between sanctioned entity-states, despite the extreme US sanction restrictions. In April 2020, Iran shipped equipment to Venezuela via air carrier so that Venezuela could begin building infrastructure for oil refineries. At the end of May 2020, Iranian oil tankers delivered oil to Venezuela in direct violation of US sanctions.

Evasion is not unique among mutually sanctioned countries. Although state-owned enterprise PDVSA was targeted in the revamp of 2019 sanctions, its subsidiary CITGO is well-known on US soil. Ironically, the US is the country outside of Venezuela with the highest number of Venezuelan sanctions connections, followed by Sweden and Spain.

Venezuelan Sanctions Outside Venezuela

Outside of Venezuela itself, the highest number of Venezuelan sanctions have US addresses. There are several sanctions trials occurring in Houston, Texas, with subsequent cases in California, Washington, Florida and, to a lesser extent, Louisiana.

Non-sanctioned entities take advantage of the blockchain development in sanctioned countries as well. In 2018, some EU countries recognized the shocks to Iran’s oil demand because of US sanctions and seized the opportunity to purchase oil for a fraction of its original cost. To avoid regulators, the purchasing countries used a special purpose vehicle (SPV) called INSTEX, designed to find a good or service that is not affected by sanctions and that triangulates the payments.

Screening for Insights

Screening solutions should have appropriate data to provide clients with the relevant risks. RDC’s GRID hosts a Bitcoin ATM list as well as an Initial Coin Offerings (ICO) lists, home to Venezuela’s Petro. RDC also captures bitcoin addresses on watchlists as they are available. In 2018, two Iranians were placed on the OFAC SDN list along with their bitcoin addresses. While bitcoin addresses are difficult to monitor, as they are pseudonymous and easy to scramble, screening addresses and/or known online aliases against sanctions’ lists is a worthwhile method for identifying a sanctioned entity on other platforms as people tend to use similar usernames across dark web and surface web stations.

Moreover, RDC hosts Sanctions Connect which goes beyond Sanctions watchlists to include entities actively trying to escape sanctions restrictions. Venezuelan vessels and aircrafts are sanctioned according to 2019 expansions. Analyzing risk codes, Watchlist (WLT) Vessels are higher in Venezuela and Iran; however, outside of those two countries, Sanctions Connect (SNX) is predominant, meaning that the entities shipping trade goods with these sanctioned countries are outside of each jurisdiction.

Vessel-Associated Risk Codes, 2015 – YTD

Strengthening Compliance

It is essential that Financial Institutions screen for risks worldwide for sanctioned subsidiaries, parallel markets, etc. This includes looking within countries that traditionally impose sanctions, such as the EU and the US, given numerous entities outside of sanctioned jurisdictions work to evade sanctions. Understanding the manners through which parties attempt to circumvent regulations will lead to a better screening solution, contributing to an effective and strong sanctions compliance program.

Beyond this, financial institutions must be aware of the depth of corruption in certain jurisdictions. It is essential to understand the geopolitical nuances of sanctioned entities and their tolerance for major economic restrictions. An over-arching issue in both Venezuela and Iran is that they are oil-rich resource cursed nations, meaning that their authoritarian governments are not dependent upon tax revenue and thereby less responsive to circumstances impacting citizens’ quality of life. If sanctioned countries continue the development of sanctions evasion programs, they will be unlikely to succumb imposers’ demands.