Financial sanctions are easier than ever for Russians to evade. Thank Bitcoin

New York(CNN Business) The West's initial salvo of financial sanctions against Russia failed to deter President Vladimir Putin from launching a full-scale invasion of Ukraine. Now the United States is taking a punitive approach, announcing another round of sanctions meant to tighten the screws on Russian banks and "corrupt billionaires."

But some experts say those measures, which so far do not target Putin himself, are becoming increasingly easy to evade, thanks in part to a surge of cryptocurrency adoption in Russia.

The US and EU sanctions rely heavily on banks to enforce the rules. If a sanctioned business or individual wants to make a transaction denominated in traditional currencies such as dollars or euros, it's the bank's responsibility to flag and block those transactions.

But digital currencies operate outside the realm of standard global banking, with transactions recorded on a public ledger known as the blockchain.

"If the Russians decide — and they're already doing this, I'm sure — to avoid using any currency other than cryptocurrency, they can effectively avoid virtually all of the sanctions," said Ross S. Delston, an expert on anti-money laundering compliance.

The US Treasury is well aware of this problem. In an October report, officials warned that digital currencies "potentially reduce the efficacy of American sanctions" by allowing bad actors to hold and transfer funds outside the traditional financial system. "We are mindful of the risk that, if left unchecked, these digital assets and payments systems could harm the efficacy of our sanctions." 

As Exhibit A, look no further than Eastern Europe, which has one of the highest rates of crypto transaction volume associated with criminal activity, according to research by Chainalysis. Websites used for illicit trades known as darknet markets brought in a record $1.7 billion worth of cryptocurrency in 2020, most of it in Bitcoin.

And nearly all of the growth in darknet market that year can be attributed to one specific Russian-language-only market called Hydra. Hydra is "by far the largest darknet market in the world, accounting for over 75% of darknet market revenue worldwide in 2020," Chainalysis wrote in a report earlier this month.

Of course, evading sanctions isn't as easy as dumping all your dollar-denominated funds into Bitcoin. It's hard to buy anything with crypto, especially big stuff, Delston says.

Take food for example, which Russia historically has imported.

"Is a food exporter somewhere in the world going to accept cryptocurrency that fluctuates every day — every moment of every day — or are they going to want the world's reserve currency, US dollars?"

A further complication: the oil trade, which makes up a huge portion of Russia's economy, is denominated in US dollars. To use cryptocurrency to buy anything, you have to have an off ramp to a government-issued currency such as the dollar, says Delston.

"It's not a complete solution for the Russian oligarchs," he says, because Bitcoin and other cryptos can be traced on the blockchain. It's harder, though not impossible, to launder those funds because of the blockchain.

There are other ways Russia could, at least in theory, mitigate the pain of sanctions by taking a page from Iran's playbook.

Like Russia, Iran is an oil-exporting country, and it remains under a decades-old near-total economic embargo by the US, including bans on all imports and sanctions on Iranian financial institutions.

But even as a pariah state, Iran has figured out how to take some of the bite out of sanctions by turning to Bitcoin mining, according to a report by analytics firm Elliptic.

Iran has a surplus of energy it can't export, so it's using it to power Bitcoin mining, which consumes huge amounts of electricity but rewards miners with payment in Bitcoin.

"The mining process effectively converts energy into cryptocurrency," writes Tom Robinson, Elliptic's co-founder. "Iran-based miners are paid directly in Bitcoin, which can then be used to pay for imports" — something Elliptic says has become all but an official policy within the Iranian government.

Elliptic estimates that Iran-based miners account for approximately 4.5% of all Bitcoin mining, which would translate to annualized revenue of close to $1 billion.