Is the war in Ukraine increasing the regulatory burden on crypto companies?

Whose side are you on? The war between Ukraine and Russia forces people to answer that question. For some in the crypto community, this may be inconvenient because if a person or project stands side by side with the West against Russia, it also means that it is adhering to sanctions. This can be difficult to reconcile with the alleged decentralized system of crypto/blockchain and its claims that it is borderless, censorship free and distributed.

Take OpenSea, the NFT marketplace, which isn’t exactly a decentralized project, but is often described as such. “OpenSea is a decentralized peer-to-peer marketplace for buying, selling and trading rare digital goods,” for example, according to CoinMarketCap.

But when OpenSea recently banned Iranian users from using its NFT trading platform — explaining that it was only adhering to US sanctions law — it sparked outrage among some NFT collectors. Documentary photographer Khashayar Sharifaee tweeted

This raises questions: Are public and government officials now more focused on crypto regulation, especially with the outbreak of the war between Russia and Ukraine? OpenSea infuriated many in its community by banning Iranian users, but did it have a choice?

Further, while major US-based crypto-related firms such as FTX, Coinbase, OpenSea, and Consensys are required to adhere to US sanctions and regulations, what about decentralized projects without an easily identifiable headquarters, leaders, or national affiliation. Will they or can they also comply, or will they receive a pass?

Finally, there is a longer-term question: will we ever have a truly decentralized market? Will the cryptoverse inevitably have to compromise with centralized institutions such as sovereign governments?

More regulatory attention

“Government authorities have definitely shown more interest in crypto regulation lately,” Swan.com CEO Cory Klippsten told Coin-Crypto when asked about recent events, adding that serious discussions about regulation have been going on for many years. “Yet the war between Russia and Ukraine has pushed crypto into the spotlight, which is why we are seeing increased public interest in these crypto regulatory developments.”

“Everyone is starting to rethink the importance of compliance and crypto for a number of reasons,” Carlos Domingo, founder and CEO of Securitize, told Coin-Crypto. “We are now seeing live the importance and effectiveness of sanctions” in connection with the war.

US regulators are putting pressure on the biggest players in the crypto world to comply. “And now somewhat decentralized crypto platforms too,” Markus Hammer, a lawyer and director at the consulting firm Hammer Execution, told Coin-Crypto. Perhaps that’s why OpenSea came down hard on Iranian users last week, even though Iran’s sanctions were reimposed in 2020.

“As regulations seem imminent, companies like OpenSea are trying to protect themselves by making sure they comply with any regulations that come in the pipeline,” Klippsten said, adding, “that’s why you see them banning Iranians.” Coin-Crypto asked for comment from OpenSea for this story, but received no response.

Will people begin to see more projects like Binance or FTX that have been vague about their geographic home base becoming clearer about where they are based? Do others want? to declarelike OpenSea last week: “We are a US-based company” that “must comply with the US sanctions law?”

“I’m not sure if OpenSea tried to hide their location,” Domingo replied. “Most people knew that the CEO and other employees were based in New York.” He also added for the record: “I don’t see OpenSea as a decentralized project at all. I think it’s pretty centralized, similar to Coinbase, Binance, and FTX.”

Rather, what we’re seeing now is that “regulators are increasingly concerned about fraud and illegal activity against their citizens and businesses, and are increasingly willing to take enforcement actions around the world, as in the case of BitMEX,” it said. Domingo. †

Still, many in the crypto community see betrayal in OpenSea’s actions — after all, blockchain-based projects should be censorship-free. Was it fair that an Iranian artist, who has nothing to do with his government’s actions, is now being denied a platform to sell his digital art?

“OpenSea must comply with US sanctions rules and laws just like any other centralized US-based company,” Klippsten said. “By contrast, a decentralized project like Bitcoin has no leader and is really permissionless. It is impossible to ban users or impose sanctions if no one can unilaterally control the project.”

It does not make it any easier that there are different types of sanction regimes. For example, the sanctions that the US is imposing on Russia are targeted. That is, they do not apply to most ordinary Russians, but rather to financial concerns and Russian elites – including oligarchs. The US sanctions against Iran, on the other hand, affect all users based in Iran.

Russians in Yekaterinburg protest against invasion of Ukraine. Source: Vladislav Postnikov

The parties may also differ in their interpretation of the sanctions. Iranian artist Arefeh Norouzii, for example, who was “taken off the platform” by OpenSea, while an Iranian citizen “doesn’t even live in Iran,” Hammer said. “In that case, I would argue that the legal basis for OpenSea’s decision to deplatform Arefeh based on their terms is inconsistent with the relevant sanctions.”

According to Domingo, “OpenSea would commit a crime by processing transactions from people living in Iran, and it’s as simple as that,” he adds:

“I know it seems unfair that people in sanctioned countries are being affected in this way because they are not responsible for the actions of their governments, but the US government has decided this is the best way to protect its citizens and interests. “

Given recent events, is it fair to say that some entities are not as decentralized as they claim? “Some infrastructure services are more centralized than they appear at first glance,” Fabian Schär, a professor in the business and economics department at the University of Basel, told Coin-Crypto, although users have other options, even if projects are not fully decentralized. “They can easily run their own full node and use alternative user interfaces.”

According to Hammer, many of these “somewhat decentralized” platforms haven’t even thought about regulating the financial markets until recently. “They thought they were in the supposedly safe ‘decentralized’ space and never considered that over time they could get caught up in the market regulation of the traditional financial world.” However, it is now catching up with them, especially fiat-slope crypto exchanges, he added.

Will DEXs Comply?

What about truly decentralized projects? Are they untouchable from a regulatory/compliance point of view? Or, given that there is some very good compliance software out there to identify “bad actors” on decentralized digital ledgers, isn’t it possible for DEXs and other decentralized projects to comply if they really want to?

“The tools are there and they’re getting stronger and more effective,” Hammer says. A good example is how Chainalysis’s forensic tools were used recently to identify the culprit behind The DAO’s famous 2016 hack, he added.

“It’s very easy for companies to comply with regulations if they want to,” Domingo agrees. “There is no shortage of tools or technology and it seems that some ‘decentralized’ projects are already doing this.”

Software solutions exist, Schär said, “and any party bridging the gap between traditional finance and decentralized finance must comply with anti-money laundering regulations and sanctions lists.” Since their entire business model relies on access to traditional payment systems, Schär doesn’t think they will compromise this access.

By contrast, “decentralized exchanges are simply smart contracts that provide a neutral infrastructure,” continues Schär. “A smart contract cannot perform these checks. However, we also need to be aware that these decentralized exchanges do not have access to traditional funding. All you can do is trade tokens.” As a result, the risks of DEXs are much smaller than those of centralized exchanges, he said.

Of course, some entities will play regulatory arbitrage for as long as possible, Domingo said. But this is a short-sighted strategy because “although technology moves faster than regulation, regulation eventually catches up.”

Overall, though, one big question remains: will we ever have a truly decentralized market? “There are some really decentralized marketplaces,” Schär says. A non-upgradable market maker with a constant function is an example, he explained:

“There are no special privileges, no external dependencies, and no one to make these decisions.”

Such projects are basically going on forever – they cannot be directly regulated. For that reason, “policy makers and regulators should focus on slip roads and use indirect regulation,” Schär added. Although, according to Hammer, decentralization is feasible, provided an organization follows two principles: it implements open-source code and is governed by a decentralized autonomous organization, or DAO.

But perhaps there will always be some behavioral constraints, even with decentralized entities, and projects will inevitably have to compromise with centralized institutions such as sovereign governments.

“Yeah, that’s how I see it,” Domingo said. “Finance will become increasingly decentralized, but adoption requires safeguards to protect investors from scams and bad actors. Eventually we will reach a kind of middle ground.”

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