OFAC‘s Bitcoin Address Listing Raises Complex Questions

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For the first time in history, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) identified two bitcoin addresses on its Specially Designated Nationals And Blocked Persons List (SDN). This development officially puts bitcoin and other virtual currencies on the sanctions map, and raises complex challenges in this space.

Recall that the bitcoin blockchain is completely open for anyone to inspect and verify. Since the ledger is open and public, anyone with the necessary skills can trace bitcoin transactions from one address to another, especially if the user is not particularly interested in keeping her transactions private. And like a bee trapped in amber, a confirmed block of transactions continues to have new blocks built on top of it every ten minutes, with no way of ever being reversed, changed, or obfuscated. This means that law enforcement, OFAC, FinCEN, or any interested party can look at a fossilized transaction record and reach conclusions about the flow of funds many years later, especially if they can link addresses to real individuals. In this regard, bitcoin is indeed much more traceable than physical cash.

This is an important point, as the OFAC listing raises interesting questions that never before had to be considered. For instance, no one can trace the dollars in bank accounts today to their origin (however many decades or centuries ago that dollar was issued). But let’s assume it is possible to ascertain that a particular dollar bill has been used in illicit activities — does this make this “dirty money” that should no longer be used? What if the recipient had no idea of its history? And if he did know, is there a legal or moral obligation to refuse that dollar bill and demand another “clean” one?

With the bitcoin blockchain, it is technically possible to trace a coin back to the day it was mined. There are concerns in the community that there will be coins that are blacklisted due to their link to illegal enterprises (such as those traceable to the Silk Road). This would lead to a bifurcation in value: clean bitcoins would command a premium while those with a shady history trade for less. A service that “cleans” those bitcoins by mixing them with others (e.g., CoinJoin transactions) could make any bitcoins that come out of that process a “grey” coin, leading to a third valuation. However, as the bitcoin blockchain ages, it is likely that due to the limited number of coins, most if not all of them will inevitably be tainted at some point. The fact that 80% of US Dollar bills have trace amounts of cocaine does not make them any less redeemable.

Below are just a few considerations that need to be taken into account in light of this development:

  1. It is clear that entities that directly transact in bitcoin must be aware of the growing list of blocked addresses. This means that there must be controls placed on entity-owned addresses to ensure coins to not come from or go to blocked addresses. But short of OFAC specifically linking addresses to individuals, there is no practical way for a third party to know whether an address belongs to a listed individual.
  2. OFAC administers comprehensive sanctions with respect to five countries: Iran, North Korea, Cuba, Crimea and Syria. Yet there is no easy way to determine whether the owner of a digital currency address is located in one of these jurisdictions, especially in cases whether the owner has full custody and control of the keys. This can cause inadvertent sanctions violations by the sender if the recipient’s address is linked to an individual residing in a sanctioned jurisdiction.
  3. Does OFAC plan to include privacy coins, such as Monero, to the list? If so, how will they enforce adherence if they cannot trace the funds? It remains unknown whether nation states have the capability of tracing these types of cryptocurrencies.
  4. I have argued before that bitcoin is speech — from the code to its implementation and actual use. When one “sends” bitcoin, one is simply publishing text to the blockchain. By banning bitcoin transactions to/from a particular address, OFAC is essentially saying, “you cannot publish this text with these specific characters to the blockchain”. It will be interesting to see whether this and other regulatory edicts are challenged in court under the First Amendment.

As the space begins to mature, and the list of sanctioned addresses grows, it will be interesting to see what compliance efforts that OFAC will expect, especially from large institutions dealing with cryptocurrency.

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