A version of this article appeared in the FT’s Global Risk Regulator.
The President of the European Central Bank, Christine Lagarde, has warned that cryptocurrencies are being used by Russian corporates and individuals to bypass sanctions over the war in Ukraine. This concern has been echoed by governments around the world. The G7 leaders, in a statement issued by the White House, stressed that measures are in place to pursue those who attempt to use cryptoassets to evade sanctions.
The novel features of cryptoassets may make them more difficult to freeze, whether by a national sanctions enforcement agency or by a private party.
Content
- US, UK and EU crypto-related sanctions
- Industry compliance with sanctions
- English Court approach to freezing cryptoassets
US, UK and EU crypto-related sanctions
Unlike the US and UK, the EU has introduced specific measures to target the amount of cryptocurrency held by Russian nationals and companies. Any person required to comply with EU sanctions law is prohibited from providing cryptoasset wallet, account or custody services to Russian nationals or natural persons residing in Russia, or entities established in Russia, if the total value of the cryptoassets of the person per wallet exceeds EUR 10,000. The European Commission emphasises that the onus is on private crypto service providers to implement adequate systems to take into account the fact that the value of cryptoassets can fluctuate substantially over a short period of time.
The US, UK and EU sanctions regimes all include forms of asset freeze/blocking restrictions. These restrictions prohibit any form of dealing with a person who is an asset freeze target, including making assets directly or indirectly available to them. While these measures are not exclusively concerned with cryptoassets, the US, UK and EU have confirmed that cryptoassets fall within the purview of asset freeze restrictions. Consequently, if an individual or company designated as an asset freeze target owns or controls cryptoassets, then those cryptoassets must be frozen.
In addition to targeting cryptoassets held by certain individuals, it is also possible for US, UK and EU sanctions authorities to designate cryptocurrency exchanges, miners or similar as asset freeze targets in their own right. While the UK and EU are yet to take this step, on 20 April 2022 the US Office of Foreign Assets Control (OFAC) designated BitRiver (a crypto mining host), and several subsidiaries as Specially Designated Nationals (SDNs). US persons and persons who are otherwise subject to OFAC’s jurisdiction must ensure that they block BitRiver’s property, and must not engage in any transactions with BitRiver.
The US, UK and EU regimes also all include anti-circumvention provisions, which prohibit attempts to circumvent the relevant sanctions restrictions. The anti-circumvention prohibitions can be particularly relevant in the crypto context. For example, in April 2022 the US sentenced Mr Virgil Griffith, who worked extensively on the Ethereum cryptocurrency platform, to 5 years in prison and imposed a USD100,000 fine for Mr Griffith’s role in circumventing US blocking sanctions. Mr Griffith funded and developed cryptoasset infrastructure in North Korea, including providing detailed instructions on how cryptoassets could be used to evade US blocking sanctions.
As the US, UK and EU authorities have all introduced measures aimed at preventing the use of cryptoassets to circumvent sanctions, private parties may face practical difficulties in complying with these rules.
Industry compliance with sanctions
In October 2021 OFAC published sanctions compliance guidance for private operators in the virtual currency industry1. The guidance includes specific recommendations on steps that private operators can take to ensure that they comply with sanctions. These include conducting risk assessments, sanctions screening clients, using geolocation tools to monitor the location of customers, using transaction monitoring tools and providing effective training for staff.
Private operators in the crypto industry, including two of the world’s largest cryptocurrency exchanges, have recently announced the proactive steps they have taken in order to ensure compliance with sanctions regimes.
In particular, Coinbase Global Inc has frozen 25,000 Russian accounts, while Binance announced that it would limit services available to Russian nationals, individuals residing in Russia and legal entities established in Russia that have cryptoassets exceeding EUR 10,0002. Binance has also confirmed that it will freeze the cryptoassets of asset freeze targets and that cardholders of sanctioned Russian banks will not be able to use them on the platform. Binance now requires Russian users to complete a proof-of-address verification.
However, the historically low regulatory burden on cryptocurrency exchanges may mean that the exchanges still only hold limited identifying information about some customers. For example, Binance has operated a policy of allowing customers to create a “basic” account, using basic functions and performing some transactions without needing to submit Know Your Customer (KYC) information. The significant fluctuation in the value of cryptoassets and the difficulty and cost involved in tracing the proceeds of cryptocurrency also create potential enforcement difficulties for both public and private enforcement bodies.
This recent focus on cryptocurrency and sanctions has prompted us to consider how easy it is in practice to freeze access to cryptoassets in a litigation context.
English Court approach to freezing cryptoassets
In a series of recent decisions, the English Courts have confirmed that cryptoassets are capable of being frozen and have shown a willingness to do so:
- Mr Justice Birss in Elena Vorotyntseva v Money-4 Limited t/a Nebeus.Com [2018] EWHC 2596 (Ch) granted a freezing order in respect of a substantial quantity of Bitcoin and Ethereum in the light of a real risk of dissipation.
- In AA v Persons Unknown [2019] EWHC 3556 a specialist company was used to track Bitcoins paid as a ransom to release a company from a malware attack. Mr Justice Bryan gave a detailed decision on why cryptocurrencies should be treated as property under English law and granted a proprietary injunction and required the exchange to provide information in relation to an account held by a defendant.
- In Ion Science Ltd v Persons Unknown and others (unreported, 21 December 2020) expert evidence was produced to trace the location of Bitcoin paid due to an alleged Initial Coin Offering fraud to two cryptocurrency exchanges. The English Commercial Court granted a worldwide freezing order, a proprietary injunction and a Bankers Trust order against the exchanges requiring them to preserve the Bitcoin (or its traceable proceeds) and to disclose specified information about the accounts in order to identify the alleged fraudsters.
- A further helpful step was taken by the Court in Ion which went on (following the disclosure and freezing orders) to grant a third party debt order – the first granted by the English Courts in relation to cryptocurrency. The disclosure order granted by the Court meant that the company who had executed the fraud and owned the (now frozen) account could be identified. When this company did not respond to the claimants’ claims the Court granted the third party debt order against the subsidiary of the exchange where the account was held.
- In reaching its decision in Ion, albeit in the context of interim relief, the Court considered that the lex situs (legal location) of cryptocurrency was where the person or company who owns the assets resides or is domiciled. In Tulip Trading v Bitcoin Association [2022] EWHC 667 (Ch) Falk J dealt obiter with these same points and clarified that where the domicile and residence of a company are different it is likely to be the residence which is relevant.
Although these are all decisions dealing with interim relief, they collectively give a strong assurance that Courts are capable of freezing cryptoassets. The Law Commission consultation on cryptoassets is likely to give further helpful analysis when it is published. But these cases do not resolve the serious issue of the practical steps that are needed to make a freezing order against cryptoassets effective.
If the cryptoassets are held in an account owned and controlled directly by the owner, then only moving them to a separate escrow account using the private key provided by the owner will prevent them from being transferred. Clearly, this requires the cooperation of the owner. English Courts can use methods such as contempt proceedings against individuals to compel cooperation, but this is still a serious limitation, especially where fraud is involved. If cryptoassets are transferred, perhaps in breach of a freezing order, it might still be possible to trace them. As mentioned above, specialist companies exist to track payments of cryptocurrencies and the analysis of these companies has been relied on in the English Courts. On-chain forensic research has become more advanced and crypto transactions are therefore more traceable than in the past, but transactions conducted peer-to-peer remain inevitably difficult to target.
Where cryptoassets are held in an account with an exchange, other practical methods of freezing may be available. Indeed, one aim of tracing cryptoassets subject to a freezing order is to determine when they pass through an exchange account, perhaps in order to be exchanged for fiat currency, and then freeze them at that point. A freezing order may be served on an exchange, who may then be compelled not to allow the frozen cryptoassets to be moved from their account, much as a bank is served with a freezing order over one of its customer’s bank accounts. An exchange may be more likely to comply with a court-issued freezing order than the underlying owner and they may also have information as to the real identity of the owner. The remedies granted in Ion, described above, are another illustration of the Court’s powers in relation to cryptoassets held in an exchange.
Overall, it is clear that the English Courts are willing and able to freeze cryptoassets, although there are significant practical difficulties in making freezing orders effective. Similarly, while private crypto providers have stated that they are prepared to freeze cryptocurrencies in response to asset freeze sanctions, this will not prevent asset freeze targets carrying out peer to peer transactions on public decentralised ledgers.
We continue to monitor the situation and our specialists are available to assist you with any queries you may have in this space.
With many thanks to sanctions trainee, Freya Reevell, for her contributions to this article.
