The United States Department of Justice has initiated the first prosecution involving the use of cryptocurrency to allegedly evade economic sanctions issued under emergency economic powers legislation. An American citizen has been accused of conspiracy to transmit more than $10 million in bitcoin to a virtual currency exchange in one of five countries comprehensively sanctioned by the United States government. Speculation is adrift that the targeted country may be North Korea. The defendant was not named in a court ruling released last week by the United States District Court for the District of Columbia due to an ongoing investigation. The case should dispel the myth that online transactions in virtual currencies are anonymous.

1. Introduction

The government has alleged in a filed affidavit that the defendant used an IP address in the United States to conspire to operate an online payments and remittances platform in the sanctioned country. Operation of the platform involved establishing a front company based in the U.S. to facilitate the purchase of domains using U.S. financial accounts to conduct financial services on behalf of the platform and its customers, and transferring virtual currency to accounts associated with the platform. The platform advertised its services as designed to evade sanctions, including through purportedly untraceable virtual currency transactions.

The defendant registered various names for the platform which were paid for by the front company. The defendant’s identifiers and IP address were also linked to a U.S.-based online financial institution account tied to the platform. The financial institution account sent and received thousands of dollars to the sanctioned country for customers of the platform. The defendant also opened an account with a virtual currency exchange (VCE 1) based in the United States from which he or she bought and sold bitcoin. That account was registered using an email account linked to the defendant and funded with fiat currency from a traditional financial institution. The defendant used the VCE 1 account to send thousands of dollars to two accounts at a foreign-based virtual currency exchange (VCE 2). The VCE 2 accounts were accessed from IP addresses that resolved to the sanctioned country shortly after funds were sent – sometimes within minutes. The defendant used the VCE 2 accounts to transmit over $10 million in bitcoin between the United States and the sanctioned country for the platform’s customers.

2. Sanctions Background

The United States Congress has authorized the President to levy sanctions when the country is faced with extraordinary national security, foreign policy or economic threats under the International Emergency Economic Powers Act (IEEPA), 50 USC s. 1701. (here) The Office of Foreign Assets Control, based in Washington, D.C., is empowered to execute IEEPA and to promulgate regulations to implement sanctions regimes. (here) The sanctions can be either comprehensive or selective, using the blocking of assets and trade restrictions to accomplish foreign policy and national security goals. The five countries that have been comprehensively sanctioned are Russia, North Korea, Cuba, Iran and Syria.

Many sanctions regimes, including the one in this case, prohibit direct and indirect importation, exportation and re-exportation of goods, services and technology without a licence from OFAC. Prohibited financial services include any transfer of funds, directly or indirectly, from the U.S. or by a U.S. person or entity, wherever located, to the sanctioned country. Financial services include virtual currency exchanges. Section 206 of IEEPA makes it unlawful for a person to violate, attempt to violate, conspire to violate, or cause a violation of any licence, order, regulation or prohibition issued under the statute.

3. The Ruling

On May 13, 2022, Magistrate Judge Zia M. Faruqui released an unusual Memorandum Opinion styled as In Re: Criminal Complaint finding that probable cause existed to believe the defendant conspired to violate the International Emergency Economic Powers Act and defraud the United States under Title 50 of the U.S. Code. (here)  The deferential opinion adopted OFAC’s guidelines that operate “in an area at the intersection of national security, foreign policy, and administrative law.” (at p. 6) Here are three key passages from the opinion that focus on the perceived anonymity of virtual currencies.

• The question is no longer whether virtual currency is here to stay (i.e., FUD) but instead whether fiat currency regulations will keep pace with frictionless and transparent payments on the blockchain. OFAC’s recent guidance confirmed that “sanctions compliance obligations apply equally to transactions involving virtual currencies and those involving traditional fiat currencies.” All “U.S. persons, including members of the virtual currency industry, are responsible for ensuring they do not engage in unauthorized transactions or dealings with sanctioned persons or jurisdictions […]” (at p. 4)
• Virtual currency is traceable. Yet like Jason Vorhees the myth of virtual currency’s anonymity refuses to die. Appearing to rely on this perceived anonymity, Defendant did not hide the Payments Platform’s illegal activity. Defendant proudly stated the Payments Platform could circumvent U.S. sanctions by facilitating payments via bitcoin. (at p. 8)
• Yet by following the (virtual) money, the government established by probable cause that Defendant was operating the Payments Platform. Law enforcement synthesized subpoena returns from virtual currency exchanges, email search warrant returns, banking information, and shell company registration information to reliably dox Defendant. Specifically, the affidavit established that Defendant opened an account with VCE 1. VCE 1 collected legally-required know-your-customer information which – wait for it – allowed VCE 1 to know who its customer was: Defendant. Defendant then funded that VCE 1 account from a USFI (United States Financial Institution) account, which was also attributed to Defendant. Finally, the IP addresses used to access the VCE 1 account resolved to Defendant’s U.S. residence. The same was true for the VCE 2 accounts […] (at pp. 8-9)

Judge Faruqui reached two succinct conclusions on the issues. “Issue One: virtual currency is untraceable? WRONG. Issue Two: sanctions do not apply to virtual currency? WRONG.” Although he may not be the first judge to use “FUD” – meaning fear, uncertainty and doubt – in a U.S. federal opinion, he might be the first to use it without defining it according to Professor Anupam Chander at Georgetown Law. (here) If you are like me, and don’t go to slasher movies, Jason Vorhees is the fictional character in the Friday the 13th movies, the sweetheart in the goalie mask. And dox? You don’t know what doxing is? You’ll have to look that one up.

4. Media Commentary

In an article titled U.S. issues charges in first criminal cryptocurrency sanctions case published today by The Washington Post, Spencer S. Hsu said the prosecution “represents a new U.S. criminal sanctions enforcement push targeting cryptocurrency transactions” used for money laundering or to do business with sanctioned countries. (here) U.S. Attorney General Merrick Garland has announced that a law enforcement task force responding to Russia’s invasion of Ukraine would be “targeting efforts to use cryptocurrency to evade U.S. sanctions.” And the U.S. Treasury Department has imposed sanctions against the Lazarus Group which has been accused of stealing $1.75 billion in cryptocurrency to support North Korea’s nuclear missile program. (here) Ari Redbord of the blockchain intelligence company, TRM Labs, and a former adviser to the Treasury Department, told the Post that Judge Faruqui’s opinion made clear that the use of cryptocurrency to evade sanctions is not only traceable but “immutable – in other words, transactions using cryptocurrency are forever.”

Cryptocurrency was hailed as a safe haven for money laundering and other dark net transactions during its early days. The reporting on bitcoin, for example, made it out to be a form of anonymous currency. The decentralized privacy attitude surrounding it contributed to the misconception that virtual currencies could not be traced. Libertarians hailed the new form of money as having the potential to free the citizens of the world from the chains of national governments and the banking industry. Unlike a traditional bank account, cryptocurrency doesn’t require that a name be attached to transactions. The cynics, however, saw it as a tool for underground transactions with dangerous consequences for the environment due to its high energy consumption.

All of that is now relegated to the waste cans of bitcoin history. As Chris Stokel-Walker said in a piece for WIRED titled US Courts Are Coming After Crypto Exchanges That Skirt Sanctions, also published today, the early misconception of anonymity overlooked that “the underpinning of cryptocurrencies – the immutable blockchain that keeps a record of every transaction made – was building a stockpile of evidence for prosecutors.” (here) As Mr. Redbord added, “it’s only because crypto moves and lives on an open ledger on the blockchain that allowed for this type of investigation” which provided the evidentiary underpinning for Judge Faruqui’s ruling.

5. Conclusion

Although this is the first case directly related to the use of virtual currency to evade sanctions, prosecutors in the United States have previously pursued other crimes involving cryptocurrency. (here) In November 2019, Virgil Griffith, a former researcher at Ethereum Foundation, was charged for helping North Korea launder money and evade sanctions. He spoke at a Pyongyang cryptocurrency conference instructing the audience how to use blockchain technology to evade sanctions. Last September, he pleaded guilty to conspiracy to violate IEEPA and was sentenced in April to 63 months incarceration. (here) Also last month, the U.S. Treasury Department and OFAC introduced sanctions against a Russian crypto mining company for helping Russia monetize its natural resources. (here) Earlier this year, the U.S. Department of Justice charged a married couple in the Bitfinex attack and in 2015 Ross Unbricht was convicted and sentenced to life imprisonment for masterminding the Silk Road darknet drug emporium. I discussed the ‘crypto couple’ and Silk Road cases in previous posts to On The Wire. (here and here) For now, Judge Faruqui’s memorandum opinion will remain redacted because the underlying criminal complaint is sealed – while the U.S. Justice Department and regulators continue to ramp up enforcement in cyberspace.