Virtual currency headwinds: OFAC and FinCEN enforcement trends and priorities

October 2022 | SPOTLIGHT | FRAUD & CORRUPTION

Financier Worldwide Magazine

October 2022 Issue

As the popularity and sophistication of the virtual currency industry grows, the US Department of the Treasury has increased its regulatory focus on the abuse of virtual currencies for illicit activity. While virtual currencies have the potential to revolutionise the financial and banking industries by increasing payment efficiency, reducing the costs of financial transactions, and growing in sophistication with respect to compliance infrastructure, industry players with limited compliance resources pose significant illicit finance concerns due to the partial or total anonymity they offer users as well as the relative paucity of well-developed and informed regulatory oversight.

These aspects make virtual currencies an attractive option to those seeking to launder illegally obtained funds, finance terrorism or evade sanctions, allowing illicit actors to undermine US foreign policy and national security interests. Below, we outline recent virtual currency-related Treasury actions illustrating the Treasury’s enforcement trends and priorities, followed by an assessment of where the Treasury’s future virtual currency-related efforts may be headed.

The Treasury’s growing focus on virtual currencies

On 18 October 2021, the Treasury published ‘The Treasury 2021 Sanctions Review’, detailing a nine-month review of how the US has evolved its tools of financial warfare and economic diplomacy since the initial implementation of sanctions following the 11 September 2001 terrorist attacks. The review highlights the growing threat imposed by digital currencies, noting that, “technological innovations such as digital currencies… reduce the efficacy of American sanctions. These technologies offer malign actors opportunities to hold and transfer funds outside the traditional dollar-based financial system. They also empower our adversaries seeking to build new financial and payments systems intended to diminish the dollar’s global role. We are mindful of the risk that, if left unchecked, these digital assets and payments systems could harm the efficacy of our sanctions”.

Following the publication of the review, on 19 October 2021, Wally Adeyemo, deputy secretary of the Treasury, requested additional funding to combat threats arising from cryptocurrency markets during his testimony before the Senate Committee on Banking, Housing, and Urban Affairs. He specifically highlighted “technical changes like the growth of digital currencies” as one of four primary challenges to the continued effectiveness of the US’s sanctions regimes. Mr Adeyemo also highlighted that the Treasury intends to respond to digital currency challenges by ensuring that US allies and partners also adopt anti-money-laundering (AML) rules for cryptocurrency exchanges and extend existing protections within their traditional financial sectors to cryptocurrencies.

Following the Review, and in acknowledgement of the increasingly prominent role virtual currencies are playing in the global economy and their risk of abuse by illicit actors, the Treasury’s Office of Foreign Assets Control (OFAC) published ‘Sanctions Compliance Guidance for the Virtual Currency Industry’ in October 2021. This guidance is aimed at educating a historically unregulated industry about OFAC’s sanctions regulations and clarifying that the virtual currency industry must abide by OFAC sanctions. The guidance specifically highlights that the entire virtual currency industry, including technology companies, exchangers, administrators, miners, wallet providers and users, plays an increasingly critical role in preventing the use of virtual currencies to evade sanctions.

The Treasury’s recent virtual currency-related actions

In addition to recently publishing guidance targeted at the virtual currency industry, both OFAC and the Treasury’s Financial Crimes Enforcement Network (FinCEN) have taken recent actions against actors in the virtual currency space. For example, on 6 May 2022, OFAC imposed its first-ever sanctions against Blender.io, a virtual currency ‘mixer’. Mixers blend anonymous transactions to hide their origin, ostensibly to provide privacy.

However, Blender.io was allegedly used by North Korea to launder stolen virtual currency. Previously, on 23 March 2022, the Treasury reported that Lazarus Group, a North Korean state-sponsored hacking group that was sanctioned by the US in 2019, carried out the largest virtual currency heist to date, involving nearly $620m, from a blockchain project linked to the online game Axie Infinity. Blender.io was also allegedly used to process over $20.5m of those illicit proceeds.

On 8 August 2022, OFAC added another virtual currency mixer, Tornado Cash, to its Specially Designated Nationals and Blocked Persons List. According to the Treasury’s press release, Tornado Cash had been used to facilitate the laundering of more than $7bn worth of virtual currency since its creation in 2019. This includes over $455m stolen by the Lazarus Group in the largest known virtual currency heist to date.

These recent OFAC sanctions actions follow other Treasury virtual currency-related actions. On 10 August 2021, FinCEN assessed a civil money penalty of $100m against BitMEX, one of the oldest and largest convertible virtual currency derivatives exchanges, for violations of the Bank Secrecy Act and FinCEN’s implementing regulations for operating as an unregistered futures commission merchant. Additionally, on 21 September 2021, OFAC designated its first virtual currency exchange, SUEX OTC S.R.O., for its part in facilitating financial transactions for ransomware actors.

In addition to these actions, both OFAC and FinCEN published advisories related to ransomware on 1 October 2020, which highlighted the use of cryptocurrency as a preferred method of payment in ransomware attacks. Furthermore, OFAC recently announced settlements of enforcement actions against two virtual currency service providers, BitGo Inc. and Bit Pay, Inc., for allegedly processing transactions associated with IP addresses in embargoed countries. At the time, these settlements represented OFAC’s first enforcement actions targeting virtual currency providers, and media reports suggest that OFAC also may be investigating others transacting in the digital currency space.

The settlements have clearly put the broader virtual currency industry on notice that they, much like the financial institutions dealing with traditional fiat currency they seek to replace, are required to comply with US sanctions requirements and should implement compliance programmes to address their sanctions risks. The settlements also underscore virtual currency companies’ responsibility to use internet protocol addresses, customer and counterparty data, and all other information available to the companies, to comply with US sanctions.

Treasury trends and priorities moving forward

As the virtual currency industry continues to expand, we anticipate increased regulatory actions by the Treasury in the virtual currency space. The Biden administration’s recent virtual currency-related actions further support expectations of increased action in this space by the Treasury. Most recently, on 9 March 2022, president Biden issued Executive Order (EO) 14067, ‘Ensuring Responsible Development of Digital Assets’.

The EO mandates a coordinated government approach to develop a policy for digital assets focused on five key priorities, including illicit finance and national security, to include clear guidance regarding the regulation of digital assets. While EO 14067 does not establish any new policies, it reflects a growing US focus on emerging technology and the government’s desire to develop an effective regulatory regime.

On 7 April 2022, in her first speech about cryptocurrency since president Biden signed EO 14067, Janet Yellen, Treasury secretary, said: “more government regulation is needed to police the proliferation of cryptocurrency and other digital assets and to ward off fraudulent or illicit transactions.” Additionally, in response to the EO, on 7 July 2022, secretary Yellen, along with heads of other relevant agencies, delivered to president Biden a framework for interagency engagement with foreign counterparts and in international fora as directed by the president. The framework is tailored to reflect certain aspects of the Treasury’s work, including to, “[m]itigate illicit finance and national security risks posed by misuse of digital assets”.

The Treasury’s increasingly frequent virtual currency-related actions over the past few years, coupled with the Biden administration’s recent actions with respect to the virtual currency industry, evidence a growing trend in US government efforts to target vulnerabilities in the virtual currency space.

Companies operating in the virtual currency industry should implement robust compliance programmes and closely monitor regulatory developments as the Treasury employs increasingly aggressive regulatory efforts to address the sanctions risks posed by the emerging virtual currency sector.

Ryan Fayhee is a partner, Tyler Grove is a counsel and Anna Hamati is an associate at Hughes Hubbard. Mr Fayhee can be contacted on +1 (202) 721 4691 or by email: ryan.fayhee@hugheshubbard.com. Mr Grove can be contacted on +1 (202) 721 4625 or by email: tyler.grove@hugheshubbard.com. Ms Hamati can be contacted on +1 (202) 721 4605 or by email: anna.hamati@hugheshubbard.com.

Ryan Fayhee, Tyler Grove and Anna Hamati

Hughes Hubbard