Russia legalizes crypto: How does it work? Will it allow it to circumvent Western sanctions?

Original title: Russia has legalised cryptocurrencies. Will this help the Russians evade Western sanctions?

Author: Yaroslav Vinokurov, Ukrainska Pravda, compiled by: 0xjs@Golden Finance

There is a fine line between love and hate, especially when it comes to the Russian government's attitude towards cryptocurrencies.

"We cannot welcome investments in such assets. We believe that Russia's financial infrastructure should not be used for cryptocurrency transactions," said Elvira Nabiullina, governor of the Russian Central Bank, in December 2021.

In July 2024, she said the exact opposite: "We expect the first cryptocurrency payment to be completed by the end of this year."

The Kremlin initially viewed cryptocurrencies as a threat. They were originally created to replace the traditional financial system, so they look like an uncontrollable tool for the regime.

However, now that the Western world has designated Russia as a state sponsor of terrorism, cryptocurrencies have become one of the last few ways to ensure payment for export and import contracts.

In the summer of 2024, the Russian State Duma (the lower house of the Russian parliament) legalized cryptocurrencies and crypto mining. The Kremlin does not hide the fact that this is a consequence of sanctions since the end of 2023, which have made it difficult for Russia to trade with friendly countries. Can cryptocurrencies save the Russian economy?

Forced to find workarounds

In 2024, Russia's foreign trade began to decline due to problems with international settlements under export and import contracts. Foreign banks refused to accept payments from Russia for fear of secondary sanctions from the United States.

The National Bank of Ukraine, which is involved in the formulation of sanctions policy against Russia, said: "Payments in dollars and euros through SWIFT are vulnerable to sanctions. Almost every day, there are reports that banks in China, Turkey and the UAE are delaying or returning payments for certain categories of products and services, which confirms the difficulties Russia has with traditional payment channels."

The problem has become so widespread that Russian President Vladimir Putin dedicated this May to solving it, "ensuring that bilateral trade is not negatively affected by third countries."

However, the situation for Russian companies has not improved since then, and perhaps the only positive economic impact of Putin's visit to China was the simplification of Russian exports of calf cartilage and Jerusalem artichokes to China.

As a result, Russian imports in the first half of 2024 were a third lower than Russian analysts had expected. According to their calculations, imports should have increased by 13%, but in fact they fell by 14% compared to the same period in 2023.

The payment problem has prompted Russian companies to look for workarounds. Some of them have begun to make trade payments through intermediaries registered in "friendly" countries such as Serbia, Belarus and Kazakhstan. But this has not helped, as trading parties have become more cautious when it comes to reaching settlements with jurisdictions suspected of evading sanctions.

Another option is to pay through the Shanghai branch of the Russian Foreign Trade Bank. However, the waiting list for opening an account at the Shanghai branch of the Foreign Trade Bank has been several months long, as the bank cannot cope with the large number of customers who want to trade through it.

In addition to being inconvenient, workarounds require additional money and time, and there is no guarantee of success. Many companies are disappointed with the traditional financial system and are looking for unconventional payment methods. For example, merchants are using barter to trade with India, exchanging oil products for aluminum.

Cryptocurrency payments are also becoming popular. Russian authorities have decided to expand and develop this method throughout the country.

Transactions with crypto

“If unpopular payment mechanisms are not developed under sanctions, the export-oriented economy may perish,” said Vladimir Chistyukhin, deputy chairman of the Central Bank of Russia, in July 2024.

Cryptocurrency - which the Central Bank of Russia wanted to ban two and a half years ago - has now become one of these mechanisms. In the summer of 2024, the State Duma passed two laws that legalized cryptocurrencies in Russia.

The first of these laws legalized cryptocurrency mining, which, in fact, was not banned in Russia before the new law was passed. From November 1, cryptocurrency mining will be officially included in the Russian regulatory framework. The law sets out requirements for those involved in mining, requiring them to register with the Ministry of Digital Transformation and provide information to the Federal Financial Monitoring Service (Rosfinmonitoring) about the cryptocurrencies they mine.

The second law legalizes the circulation of crypto assets, making Russia one of the few jurisdictions in the world to recognize cryptocurrencies at the national level. However, unlike countries such as El Salvador, which have adopted Bitcoin as an official currency, Russia will not accept cryptocurrencies as a means of payment.

The Kremlin only allows the use of cryptocurrencies for the settlement of cross-border transactions.

Cryptocurrencies have previously been used in these transactions, but only informally. "Now customs will be able to recognize these payments: companies will be able to prove that the goods were paid for in cryptocurrencies," said Vladyslav Vlasiuk, Ukraine's sanctions policy commissioner.

Crypto payments in Russia are currently mediated by agents: Russian importers transfer rubles to agents, who buy crypto assets from exchange operators and pay the recipients.

Russians typically use stablecoins (tokens whose value is pegged to traditional currencies such as the dollar) for such transactions. USDT and USDC are the most popular stablecoins. Vlasiuk said they are central to the Kremlin's legalization of cryptocurrencies.

The use of middlemen increases the cost of cryptocurrency transactions for Russian importers. This is one of the reasons why cryptocurrency payments have not yet provided Russians with a viable alternative to traditional payment methods, despite the difficulties of using the banking system to pay in dollars or euros. Cryptocurrency legalization should make cryptocurrency payments cheaper and easier — at least in theory.

How does it work?

There is very little information about how cryptocurrency payments work in Russia: the new law does not set requirements for those who want to pay with cryptocurrencies. The Russian State Duma has tasked the Central Bank of Russia with drafting rules for regulating cryptocurrency trading. The bank has been given practically carte blanche to design a cryptocurrency trading system and draft rules governing the payment process and parties to a transaction.

Back in 2021, Central Bank of Russia Governor Elvira Nabiullina was skeptical about legalizing cryptocurrencies, but a lot has changed in Russia over the past three years.

The Central Bank of Russia will be able to establish experimental legal regimes (ELRs) in various sectors of the economy, select participants and clarify their roles. ELR participants will not be subject to certain Russian federal laws.

Cross-border transactions are expected to take place within the ELR of financial markets. The central bank will also create an ELR for organized cryptocurrency trading. Russia may establish an official cryptocurrency exchange or grant cryptocurrency trading rights to existing exchanges. Russia's largest exchange, the Moscow Stock Exchange, refused to participate in the experiment.

The Central Bank of Russia will also have to integrate cryptocurrency payments with the national payment system, which consists of the national payment card system, the fast payment system, the central bank payment system, the deposit system, and the financial information system.

The Central Bank of Russia may make the first cross-border cryptocurrency payment by the end of 2024. But to achieve this goal, Russia must not only design the appropriate technical system, but also figure out where and how to get enough cryptocurrency to service billions of dollars in foreign trade turnover.

Will this get around sanctions?

If Russia's plan to use cryptocurrencies to bypass the Western financial system is to succeed, it will not be enough to legalize crypto payments in Russia. Its trading partners must also accept such payments, which may still be difficult.

In China, for example, cryptocurrencies have been banned since 2021. (The ban does not apply to Hong Kong.) In order to use cryptocurrencies in transactions with Russia's largest trading partner, Moscow will have to use a series of intermediaries, which will make transactions more expensive.

Russia's other BRICS partners - Brazil, India and South Africa - also seem in no hurry to legalize cryptocurrencies, even for international payments.

The cryptocurrency market is no longer a completely unregulated or government-regulated area. Crypto exchanges operate according to financial surveillance standards and must comply with Western sanctions to avoid secondary restrictions.

Ukrainian cryptocurrency analysts believe that Russia's new plan is essentially shooting itself in the foot. Cryptocurrency trading could make it easier for Western governments to expand sanctions.

“It’s easy to track all participants in blockchain exchanges, as they are recorded in blocks. There are many companies around the world that can analyze this stuff. Once Russian companies start using cryptocurrencies, it will be much easier to find their counterparties,” said Nataliia Drik, president of the Ukrainian Blockchain Association.

In addition, the use of stablecoins in international trade will make Russian businesses more vulnerable to further restrictions, which seems inevitable.

“The pressure for sanctions against individuals (especially participants in the Russian Central Bank’s cryptocurrency pilot project) and new areas (of the Russian economy) will increase, for example, by developing additional measures to restrict Russian customers’ access to the market of stablecoins pegged to the US dollar, which, according to several press investigations, is the cryptocurrency used by Russian companies for settlements,” the National Bank of Ukraine said.