Sanctions evasion in the crypto-asset economy

Australian targeted financial sanctions

Australia’s autonomous sanctions are administered under the Autonomous Sanctions Act 2011 (Cth) and the Autonomous Sanctions Regulations 2011 (Cth). Targeted financial sanctions are typically the preferred regulatory mechanism and are noted for their broad application in prohibiting dealings and imposing asset freezes in relation to a designed person or entity. Breaching Australian sanctions law can subject an individual or body corporate to criminal liability.

Recently, global efforts sanctioning the Russian economy have catalysed the creation of a global collaborative working group – the Russia-Related Illicit Finance and Sanctions Financial Intelligence Units Working Group (Working Group).

The Working Group, which includes AUSTRAC and their global financial intelligence unit counterparts has underscored the cooperation with law enforcement, prosecutors and the private sector in Australia to achieve the goals of the Working Group and more generally to combat their associated illicit activities including money laundering, sanctions evasion, cyber threats and corruption.

Further, AUSTRAC’s recent financial crime guides are a stark reminder to financial institutions, authorised deposit taking institutions and Digital Currency Exchanges (DCE) of emerging red flags in relation to Crypto-Assets, including sanctions evasion.

The crypto-asset ecosystem

The FinTech Note identified six areas which broadly capture the infrastructure and associated bodies’ in the Crypto-Asset economy:

• Operating the infrastructure;
• Storing private access keys for users;
• Issuing, creating and destroying Crypto-Assets;
• Validating transactions;
• Managing reserves; and
• Providing custody and trust services for reserve assets.

DCEs in particular, serve as the ‘on-and-off’ ramps in order to facilitate this Crypto-Asset ecosystem. As with any emerging technology, the landscape is fast moving as new products and asset classes regularly emerge.

• Digital Currency: AUSTRAC’s recent Guidance has highlighted the risks posed by Crypto-Assets being used to circumvent sanctions, whether Australian sanctions or sanctions imposed by another country. These risks include transactions with sanctioned wallet addresses, people of interest listed on government websites and international exchanges with less stringent customer due diligence processes, including those owned or hosted in high risk jurisdictions;
• Non-Fungible Tokens (NFTs): As NFTs are often purchased with digital currencies and where the inherent value of NFTs is extremely subjective, NFTs lend themselves to exploitation for malicious means, including being used as vehicles of value transfer in the circumvention of international sanctions. NFT collections located in high risk jurisdictions and significant sales of NFT collections purchased from mixers were recently flagged as risks to consider in the Joint Chiefs of Global Tax Enforcement NFT Marketplace Red Flag Indicators Guide; and
• Decentralised Finance (DeFi): Although still in development, DeFi’s ability to facilitate financial activities such as trading, loans and investments makes it susceptible to sanctions evasion because of the lack transparency, regulation and anonymity. The ease with which DeFi can facilitate global and cross-border commercial transactions is based on in its ‘decentralised’ and unregulated nature.

Monitoring sanctions risk

Given the unprecedented scale of current global sanctions in response to geopolitical events and the increasing use of Crypto-Assets, reporting entities under the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) should consider the following in responding to sanctions risks in the Crypto-Asset economy:

• Screening: transaction monitoring in relation to Crypto-Asset services and products is likely to be more challenging compared to traditional transaction monitoring models in centralised financial systems; in part due to the anonymised and unregulated nature of Crypto-Assets. Further, these traditional approaches to transaction monitoring may not necessarily be adaptable to the developments of block chain technology. Australian regulators such as AUSTRAC, may overtime consider best practice for industry and balance competition and compliance;
• Jurisdictional Risk: in light of recent geopolitical events, reporting entities will need to be alert to these current and emerging tensions and trends, which heighten the risk of sanctions evasion through Crypto-Assets. This could be achieved by monitoring emerging markets, particularly those subject to international sanctions and other capital market controls, which can increase the reliance on Crypto-Assets. As an example, the FinTech Note considered the popularity of Crypto-Assets in Russia, as a result of the distrust of institutions and combination of relatively large populations of skilled computer programmers with fewer economic and investment opportunities; and
• Relationship Management: reporting entities, including financial institutions, authorised deposit taking institutions and DCEs will be major contributors to the Crypto-Asset economy. Despite their respective competitive interests, each of these reporting entities have mutual benefits in one another remaining AML/CTF and sanctions compliant in order to facilitate the Crypto-Asset ecosystem. Recent trends concerning ‘de-banking’ are a good example of why relationship management is key.