Cryptocurrencies and the war in Ukraine | VOX, CEPR Policy Portal – voxeu.org

The cryptocurrency exchanges have only done what is legally required of them when sanctioning Russia for its invasion of Ukraine, unlike the mainstream financial institutions whose restrictions on the Russians generally exceeds what is required by law. This column argues that the implications for the future of cryptocurrencies will be considerable.

The fundamental idea behind cryptocurrencies was the creation of a currency and a financial system that exist outside of the mainstream, motivated by libertarian visions of the world. The crypto advocates often say the mainstream system is corrupt, and the only way to fix it is technology that is pure. A lovely idea in theory, but what about practice?

The financial authorities dont like financial intermediation that bypasses their demands. Standards such as know your customer (KYC) and anti-money laundering become meaningless if the unsavoury elements of the financial world can do their business in crypto exchanges that refuse to comply with what the financial authorities see as legitimate demands and bypass any inconvenient rules (Bindseil et al. 2022).

For the crypto exchanges, however, reality came knocking. The financial authorities were too powerful, and most crypto exchanges now comply with KYC and anti-money laundering demands. After all, the alternative is being cut off from the rest of the financial system, which would not be good for business. If one cannot make a round trip from fiat to crypto back to fiat, most clients will allocate money elsewhere. Some rogue exchanges have refused, catering to the diehard libertarians (plus criminals and those subject to sanctions).

The crypto exchanges maintain their independent streak. When Russia invaded Ukraine, the governments in the West imposed sanctions, targeting a small set of individuals intimately connected with the Russian regime (Kwon et al. 2022). Many mainstream financial institutions, such as Visa and MasterCard, have gone above and beyond that to further limit Russian access to their firms services. Russian names find it very difficult to operate in the West, not usually for legal reasons but because the financial firms servicing them have opted not to do business with them. Whether legal or not, these firms act with the connivance of the financial authorities and the strong support of political leadership and popular opinion.

Not crypto. The crypto exchange Binance said, To unilaterally decide to ban peoples access to their crypto would fly in the face of the reason why crypto exists. And its competitor Kraken was more explicit: Bitcoin is the embodiment of libertarian values, which strongly favour individualism and human rights. It cited the law, saying it cannot freeze the accounts of our Russian clients without a legal requirement to do so.

How important is crypto to Russia? I suspect the Russian government couldnt care less what the crypto exchanges do and that its longer-term goal is to prevent crypto use in Russia, as it gets in the way of social control. Crypto is especially useful in countries where the government is most likely to dislike it, places where governments like to closely monitor and control citizens and/or extract significant rent from the financial system. Most legal restrictions on crypto use come from such countries (Danielsson 2021).

While the Russian government might not like crypto, that does not apply to the regular Russian citizen. On the contrary, they are enthusiastic crypto users, in the top 20 of crypto adoption and third in crypto transfers.

The difference in attitude between the crypto exchanges and mainstream financial institutions raises interesting questions that will continue to reverberate. For example, suppose the consensus is that Russian names should be punished for what the Russian government is doing, for whatever reason. In that case, those Western firms that refuse to do so are put under a difficult political spotlight.

The political attitude of the crypto experiences can only strengthen the hand of crypto opponents. Expect to see increased calls for restrictions on crypto activity in the West, motivated by the Ukraine innovation and the prevalence of bitcoin as ransomware payments.

The crypto exchanges do not want to engage with these issues and have remained neutral on the Russian sanctions, citing political ideology for only doing what is required by law. The reason is clear. The most vocal crypto advocates are the libertarians who want to keep their money outside the mainstream. The crypto exchanges need to be seen as echoing those views, regardless of what they do in reality. That political mission is key to crypto success.

Compliance with legal and political demands from financial and political authorities, as well those of the public, threatens crypto adoption and the price of cryptocurrencies, raising interesting questions about the future of crypto. The libertarian values, so dear to crypto advocates, are meaningless if the financial authorities can compel the crypto exchanges to comply with their demands.

The crypto exchanges will be in a particularly tricky situation if the Russians are seen to be using cryptocurrencies on a large scale to avoid Western financial sanctions, both legal and political.

The crypto exchanges might be damned if they do and damned if they dont.

Suppose they operate in a jurisdiction that complies with the demands of the mainstream system. In that case, the authorities can force them to cut off today those Russians that the governments put on their sanctions list and then to comply with whatever the authorities choose to demand in the future. Some crypto exchanges will find a way to operate outside of the long arm of the Western financial authorities. Even then, it will be a struggle for them to maintain access to mainstream financial institutions that can provide fiat settlement.

When the crypto exchanges comply, they join the mainstream, taking cryptocurrencies with them. So, the ideology is flushed down the drain, and one of the main selling points, if not the main selling point, for crypto is gone. So, it would not be good for the price of bitcoin.

If the crypto exchanges do just the bare minimum and issue political statements justifying that, like Binance and Kraken, they are seen as favouring the opponent of the day today Russia, tomorrow, who knows? That creates opposition, fuels calls for banning crypto and makes regular investors reluctant to invest in crypto. Not good for value either.

Crypto has joined the mainstream. The war in Ukraine exposes the consequences. Exciting times for it.

Authors note: I received excellent comments from Nikola Tchouparov on this piece. All errors and opinions are mine.

Bindseil, U, P Papsdorf and J Schaaf (2022), The Bitcoin challenge: How to tame a digital predator, VoxEU.org, 7 January.

Danielsson, J (2021), What happens if bitcoin succeeds?, VoxEU.org, 26 February.

Kwon, O, C Syropoulos and Y Yotov (2022), Extraterritorial sanctions: A stick and a carrot, VoxEU.org, 4 March.

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Cryptocurrencies and the war in Ukraine | VOX, CEPR Policy Portal - voxeu.org