Crypto and Conflict: Crypto's Role in the Russia-Ukraine Crisis

The trouble with crypto is that it's hard to control.

Russia's invasion of Ukraine sent shockwaves around the world. The attack drew condemnation from many world leaders, and many governments quickly introduced sanctions against Russia and sent aid to Ukraine. Cryptocurrency and global equity markets initially tumbled on news of the invasion.

However, crypto prices have since rebounded. Bitcoin (BTC) fell to below $35,000 when Russian forces entered Ukraine, but has since risen briefly above $44,000 -- up about 25%. Many have questioned what role cryptocurrency will play in this emerging conflict. In particular, they want to know if it could help Russia get around strict economic sanctions.

Is crypto a conflict currency?

Reuters recently labeled crypto "conflict currency," in part because of the dramatic increases in crypto trading in both Ukraine and Russia in recent days. It points out that cryptocurrency could see broader adoption as a safe haven asset in times of geopolitical turmoil.

Cryptocurrency has been used by refugees as a way to move money for several years. It can be difficult for migrants and refugees to transfer assets -- carrying large amounts of cash is risky, and bank accounts may get frozen or be difficult to access from a new country. Some opt instead to put money into crypto, and convert it into a fiat currency further down the line. As a result, crypto could be of some help to the half million Ukrainians already seeking refuge in neighboring countries.

Digital assets have also been used to raise funds and send aid to Ukraine. The crypto community has so far donated over $22 million in crypto to support the Ukrainian government. Mind you, there's no real reason the fund-raising had to be done in crypto rather than normal money. But it's a double-edged sword -- pro-Russian groups can also use cryptocurrency to raise money, and the sanctions mean they might otherwise struggle to receive fiat donations.

Which brings us to the biggest issue: the degree to which cryptocurrency could help Russian organizations evade sanctions. The sanctions imposed by the United States, European Union, United Kingdom, and other countries are some of the harshest ever. Amongst other things, they target Russia's central bank, and attempt to stop it from cushioning the country against the economic impact. According to The Economist, "That means some, or even much, of Russia’s national war chest can be frozen."

Can Russia use crypto to evade sanctions?

The wide-reaching sanctions seek to block transactions with Russian banks, stopping them from using various international systems to process payments. The moves also block trade with various sectors of the Russian economy, and impose controls -- such as freezing assets -- on specific individuals and businesses.

One of the big ideas behind Bitcoin is that it doesn't need the backing of a central bank or government. It's a decentralized currency that cuts out the middleman. There are many ideological benefits to this. But the downside of an asset that operates outside the financial system is that it's hard to control.

Crypto may help certain Russians mitigate the impact of sanctions in certain situations. But it probably won't be as simple or as widespread as some headlines suggest, because crypto transactions can be traced. They are stored on a public blockchain, and it is possible to identify specific sanctioned wallet addresses. To some degree, the crypto industry could implement the same economic sanctions, just as it's been able to freeze wallets containing stolen funds.

Another reason it will be difficult to evade sanctions through crypto is that many crypto exchanges have know-your customer (KYC) and anti-money laundering systems in place. At some point, Russia will need to move its crypto into a fiat currency, which it is unlikely to be able to do in large quantities without triggering alarm bells. According to Bloomberg, the White House has already asked crypto exchanges to restrict accounts owned by sanctioned individuals.

On the other side, Russia will be able to continue mining Bitcoin. A large number of ransomware attacks last year originated in Russia, and one cybercrime group has already pledged to support the Russian government in the current conflict. We can assume that cryptocurrency will generate income that's not subject to sanctions. It remains to be seen how much this is, and how much it will dent the impact of sanctions.

What this means for investors

The situation with Russia highlights a murky aspect of the crypto world that some investors would probably prefer to ignore. Blockchain technology has the potential to transform whole industries, but it also gets used for less salubrious causes.

One way to avoid the risk of handling illicit cash is to only use cryptocurrency exchanges with strong KYC requirements. It isn't perfect, but exchanges that verify people's identities and monitor transactions for illegal activity are less likely to be used by criminals.

Investors would also do well to expect increased regulation sooner rather than later. Authorities were already concerned about the potential for digital assets to undermine economic sanctions, but have not yet taken steps to address this problem. The president of the European Central Bank says this regulation is now "critically important."

Several analysts believe the recent rise in crypto prices is due to speculation that Russia might use crypto to bypass sanctions. If this is the case, crypto investors should be prepared for prices to drop again when it becomes clear that the reality isn't quite that simple.