US Agencies Unite with Digital Assets Action Plan to Tackle Illicit Finance

By David Williams, ACSS Editor
December 4, 2022

Millions of consumers, investors and businesses have exposure to digital assets, which experienced a boom in the pandemic like a feverish gold rush. The growth led to Executive Order 14067, issued to guide their “responsible development.” The EO specified digital assets as chiefly comprising cryptocurrencies, stablecoins, and central bank digital currencies (CBDCs).

The actual value of crypto, how it is “mined” and rash speculation have led to broad debate, protest and huge financial wins and losses. In sanctions, attention has been directed toward unearthing actual and potential clandestine operations that circumvent rules and regulations.

To agencies like the Office of Foreign Assets Control (OFAC), the nature of crypto itself is the primary concern. Its opaque, malleable form and covert transfer methods can obscure the origin of funds and the actors’ identities in illicit contracts.

The designation of Tornado Cash is one of a spate of OFAC actions targeting digital assets. Others include cryptocurrency exchanges associated with Russian ransomware activity and the centralized mixing service “Mixers” are services or software that accept and commingle cryptocurrency from multiple users, clouding the source of the funds. They are the bane of US government regulators and law enforcement agencies because of their utility in laundering the proceeds of illicit activities.

US Treasury Takes Action

The US Department of the Treasury responded with Action Plan to Address Illicit Financing Risks of Digital Assets, one of three reports pursuant to sections 4,5 and 7 of EO 14067. The other two are The Future of Money and Payments and Implications for Consumers, Investors, and Businesses. The Financial Stability Oversight Council followed shortly after with Report on Digital Asset Financial Stability Risks and Regulation, which reviews financial stability risks and regulatory gaps posed by digital assets and provides recommendations.

Secretary of the Treasury Janet Yellen described the reports as identifying “the real challenges and risks of digital assets used for financial services. if these risks are mitigated, digital assets and other emerging technologies could offer significant opportunities.” Yellen called on government stakeholders to work together to make progress.

The action plan calls for further interagency coordination, prioritizing risk monitoring, working with international partners to improve cooperation on and implementation of international AML/CFT standards, strengthening US regulations and operational frameworks, and improving private sector compliance and information sharing, among others.

The actions address the illicit financing risks that the US government has identified in its national risk assessments (NRAs), including virtual assets, a subset of digital assets that does not include central bank digital currencies (CBDCs) or representations of other financial assets, such as digitized representations of existing securities or deposits.

“The US government has also seen instances of virtual assets being used to fund the activities of rogue regimes, such as the recent thefts by the Democratic People’s Republic of Korea (DPRK)‐affiliated Lazarus Group, and to finance terrorism, although these remain limited in scale,” the report says.

“States and groups involved in exploiting the digital economy for sanctions evasion have used existing virtual assets, and many have developed or are trying to develop CBDCs or virtual assets backed by the state (such as Venezuela’s petro) to aid in sanctions evasion. Additionally, proliferation networks are increasingly embracing certain types of virtual assets that enhance user anonymity.”

The report points out that DPRK actors have compromised computers and network systems to generate virtual assets – cryptojacking – which could present sanctions risks to users that pay transaction fees unwittingly to these actors. It cites Iraq and Syria, where ISIS received donations for refugee camps through “various means, including virtual assets, which are converted into cash via hawaladars, where they are subsequently sent to the camps.”

The report says virtual assets can be sent directly to ISIS supporters in northern Syria, often to Idlib, or indirectly via Turkey, where ISIS can access them through virtual asset trading platforms. Some al Qaeda facilitators, it says, are exploring raising and moving funds in virtual assets. In particular, al Qaeda and affiliated groups have used social media platforms, the report says, to solicit virtual asset donations and virtual asset vouchers to transfer money to members in Syria.

Obligations the Same Whether Fiat or Crypto is Used

OFAC, in 2018, clarified through FAQs that sanctions compliance obligations – regardless of whether a transaction is denominated in virtual assets or traditional fiat currency – are the same. In 2021, OFAC provided greater detail in its publication Sanctions Compliance Guidance for the Virtual Currency Industry.

In the same year, OFAC agreed to a $507,375 settlement with US virtual asset payment service provider BitPay for processing virtual asset transactions between the company’s customers and persons in sanctioned jurisdictions. In 2021 it also designated a digital asset service provider for its part in facilitating ransomware payments. It has since designated 11 other targets in the digital asset ecosystem and included over 150 wallet addresses as identifiers on the List of Specially Designated Nationals and Blocked Persons.

OFAC this year designated its first mixer,, in connection with the facilitation of DPRK illicit activity and subsequently designated Tornado Cash in connection with the laundering of more than $7 billion of virtual assets since its creation in 2019.

Priority Actions for the US

The action plan lists priorities for US government departments and agencies.

  • Monitor emerging risks. Keep an eye on the development of the digital assets sector and its associated risks to identify gaps in legal, regulatory, and supervisory regimes. Supporting actions include accelerating training on blockchain analytics and other emerging technologies.
  • Improve global AML/CFT regulation and enforcement.
  • Update BSA regulations to safeguard the US financial system from all threats and illicit financial activity, whether facilitated by fiat currency or digital assets.
  • Strengthen US AML/CFT supervision of virtual asset activities.
  • Hold accountable cybercriminals and other illicit actors. Use Treasury tools, including sanctions and special measures, to expose and hold accountable ransomware and other actors in the ecosystem involved in or facilitating illicit activities and cut them off from the international financial system.
  • Engage with the private sector. Ensure it understands existing obligations and illicit financing risks associated with digital assets.
  • Support US leadership in financial and payments technology. Promote a modern and evolving domestic payments system that is transparent and efficient.

Much Work Needs to be Done

The US has its work cut out. Iran approved regulations in the summer for trading with cryptocurrencies, which many see as an invitation to circumvent trade sanctions. Iran offers comparatively cheap electricity, too, and might be a good location for mining, considering the high energy consumption for creating crypto, a nexus that Iran can exploit if it has not already.

In Russia, Alexey Moiseev, the Russian ministry of finance and undersecretary of the central bank, said Russia’s stance on crypto needs softening so that crypto assets can be legally adopted for international payments, which have become more difficult because of sanctions.

In a Harvard University Department of Economics paper published on November 17, Hedging Sanctions Risk: Cryptocurrency in Central Bank Reserves, author Matthew Ferranti says central banks may shift their international reserve holdings to protect themselves ex-ante against the risk of financial sanctions by fiat reserve currency issuers.

“From 2016 to 2021, countries facing a higher risk of US sanctions increased the gold share of their reserves more than countries facing a lower risk of US sanctions,” Ferranti writes. “Assuming mean-variance preferences, a modest risk of sanctions significantly increases optimal gold and Bitcoin allocations. If a central bank cannot acquire sufficient physical gold to hedge its sanctions risk, the optimal Bitcoin share rises further, suggesting that gold and Bitcoin are imperfect substitutes.

“I conclude that sanctions risk may diminish the appeal of US Treasuries, propel broader diversification in central bank reserves, and bolster the long-run fundamental value of both cryptocurrency and gold.”

Digital assets are infiltrating the economies of their host nations willingly, unwittingly and with resistance. Whether they form part of a nation’s financial system or stay on the outskirts inviting bad actors to use them for nefarious means is not clear. Their role has yet to be fully and clearly defined. How long that takes is anyone’s guess.

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