How Russia's invasion of Ukraine is a litmus test for cryptocurrency exchanges

How Russia's invasion of Ukraine is a litmus test for cryptocurrency exchanges

Exchanges have refused to exclude Russian users from using their services. However, there are technologies that could help them uphold their principles and identify bad actors.

Many companies have pulled out of Russia to protest Russia's invasion of Ukraine. So far, the major cryptocurrency exchanges in the U.S. have opposed this and said they will not do so unilaterally.

This is a principled stand and is in line with the guiding ethos of the cryptocurrency community. After all, these markets serve as an alternative to markets dominated by government interference. And in Russia, as in Venezuela and other areas of economic chaos, cryptocurrency is an important tool for ordinary citizens to resist financial totalitarianism.

Max Galka is the founder and CEO of Elementus, a New York-based blockchain and crypto analytics company.

As long as the U.S. Treasury and other financial regulators don't force crypto markets to pull out of Russia, this principled stand is also defensible. Of course, if a federal ban on Russian access to U.S. financial markets goes into effect, there will be no flexibility or tolerance for inaction. All U.S.-based cryptocurrency exchanges will have to comply. And ignorance would be no defense.

A Third Way.

There is a third path that cryptocurrency markets should consider between these two positions - one that would preserve their core ethos while averting one of the most central threats to crypto markets at large.

In this case, it is worthwhile for the crypto community to explore such options. Russia, after all, is not just another nation with crypto users. According to one estimate, around 17 million Russians - about 12% of the country - own cryptocurrencies (that's about 50% more than Americans). These numbers may understate the use of cryptocurrencies in Russia, as the value of the Russian ruble has plummeted. Putting sanctions on such a market would punish anyone in a large economy, no matter what.

But Russia is also the source of more than half of the questionable and illegal crypto and blockchain transactions, according to our own estimates. An Elementus report released last month found that five of the eight deadliest ransomware groups operate out of Russia, and that the other three may also have ties to that country.

Ransomware and other criminal activity originating in Russia rely on this access to crypto markets.

For years, crypto exchanges have shied away from blocking bad actors because of their firm belief that Bitcoin should be fungible and blockchains should be open, decentralized, and free from government interference.

More critically, many exchanges rightly argued that they did not previously have the means to systematically distinguish between good and bad actors and identify the sources of illegal activity.

That is no longer the case. Technology now exists that allows financial institutions to review the blockchain of any cryptocurrency and find out who owned what and when, relatively quickly and efficiently. Criminals who thought they could hide their money by transferring ill-gotten gains into cryptocurrencies are shocked, as many of those dollars have already been identified and recovered.

Of course, no technology is perfect, and criminals are always one step ahead of the law. In this case, if they are using Mixers, Tumblers and Coinjoins as "crypto laundries" to cover their tracks, there are limits to what current technology can do to follow the digital breadcrumbs. Human judgment also plays a role in that the nature of the technology sometimes makes it difficult to make a definitive judgment about who is behind these crimes.

So cryptocurrency exchanges have the opportunity to maintain the principled stand that they will not unilaterally exclude Russian customers, while at the same time limiting access to criminal elements - and those responsible for Russian aggression in Ukraine, if applicable. And they can do both without violating their liberal ethos.

A First Step for Exchange.

The first step in the right direction is for exchanges to identify their unwitting exposure to various potentially suspect companies. If sanctions require exchanges to divest from Russian government officials - or key supporters - those markets need to know who to target. Many Russian customers are not government officials or war supporters and should be spared the impact of such sanctions.

With technology in place, major exchanges can quickly determine how many Bitcoin transactions originated in Russia. If such crypto activity is illegal and linked to ransomware, darknet markets, or other illegal activity, wouldn't it be in the exchanges' own interest - regardless of sanctions - to block it?

Those shaping cryptocurrency markets - many of which are listed and therefore regulated entities - have the ability to pre-empt compliance-focused measures and pre-emptively block illicit activity from Russia.

Exchanges can then uphold a principle that must be defended.

Cryptocurrencies are a store of value that is independent of government arbitrariness and political interference. But it is not a place where criminals can store their ill-gotten gains - and we must not allow that to happen.