Russiaʼs crypto mining ambition ups sanctions risk in a sector with little due diligence

Russiaʼs recent legalisation of cryptocurrency mining has increased sanctions risk in a sector that conducts little or no due diligence. Crypto asset service providers and banks seeking to offer crypto custody currently have no way of determining the provenance of bitcoin, experts say.

“In a world where the Kremlin is increasingly isolated and fixated on foreign influence operations, there is a strong incentive to mine virgin bitcoin for cross-border activities,” writes Neil Barnett, chief executive at Istok Associates, an intelligence consultancy in London. “And, as is typical of post-Soviet Russia, private-sector players conduct covert activities for the state and enrich themselves at the same time.”

Cryptocurrency is useful in evading sanctions and paying for embargoed military equipment, he adds.

Investing in mining operations

Russia is increasingly investing in bitcoin operations in its “shadow territories”, such as Transnistria, Donbas and Abkhazia. It is also encouraging allies in the so-called BRICS (Brazil, Russia, India, China and South Africa) countries to host its mining operations. In October, Russia used the BRICS Business Forum in Moscow to announce that its sovereign wealth fund, the Russian Direct Investment Fund, would construct bitcoin mining and artificial intelligence computing facilities for BRICS nations, together with sanctioned data centre operator BitRiver. Russia-backed mining operations have now popped up in Ethiopia and Argentina.

Despite Russiaʼs heavy involvement in the sector, most mining pool operators will take on board anyone who wants to contribute hash rate, which is the speed at which miners can verify transactions on a blockchain. The only things contributors need to supply is an email and blockchain address, crypto experts say.

“The challenge is that we don’t know the participants involved in the process of mining or the level of criminality involved; because of that uncertainty, the foundation of the industry may prove questionable, like a house of cards built on shaky ground. If the US discovered that 40% of the hash rate comes from sanctioned or uncooperative countries, how would that impact the prospect of a US bitcoin strategic reserve?” said Neil Samtani, chief executive at VASPnet, a due diligence provider in Gibraltar covering the virtual asset service provider industry.

One attempt to perform due diligence on hash rate called knowyourhashrate.com began in 2020, but shut its doors a few years later after enduring serious threats and harassment.

Energy to crypto

Last year, Russian president Vladimir Putin signed a law creating regulations for mining cryptocurrencies, allowing miners to validate blockchain transactions and therefore make and receive international payments in crypto assets. That law permitted Russia’s crypto mining sector to become the second largest globally after the US, said Bob Savic, a trade, sanctions and regulatory expert at Geopolitical Intelligence Services in London.

“Russia’s crypto mining sector has been increasingly supported by major state companies in both the energy and financial spheres, all of which have struggled under Western sanctions,” Savic said in a paper. Energy company Gazprom and aluminium miner Rusal, as well as Sberbank and other Russian companies, have used crypto mining to recoup some of the income lost under international sanctions imposed after the invasion of Ukraine, he added.

“Crypto mining converts the energy that Russia is struggling to sell on the international market due to sanctions into cryptocurrencies. Specifically, into bitcoin, the digital currency on which 95% of Russian miners focus their efforts,” Savic said.

Exchanges’, potential custodians’ response

In 2022, the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) sanctioned companies operating in Russia’s virtual currency mining industry. At the time, Russia’s crypto mining sector was the world’s third largest, OFAC said.

Leading crypto exchanges contacted by Compliance Corylated declined to describe their approach to checking cryptocurrencies’ provenance to determine whether they were mined in jurisdictions or by actors subject to sanctions.

Gemini said it has a comprehensive financial crime programme in place and a range of blockchain analytics controls to comply with applicable sanctions regimes. It did not say whether it specifically checks where crypto assets were mined and by whom.

KuCoin rigorously monitors asset origins and complies with global sanctions, a spokesperson said. However, last week it pleaded guilty to operating an unlicensed money transmitting business in the US and failing to implement effective anti-money laundering controls. It was fined almost $300 million and agreed to exit the US for at least two years.

Binance, Coinbase, Bitstamp, OKX, Kraken, and Robinhood did not respond for requests for comment on crypto mining risks.

Spokespeople at Citi, BNY Mellon, JP Morgan and State Street — all firms seeking to offer custodial services for crypto — did not respond to a request for comment.