Foreign Policy | Tanvi Ratna: As the United States expands its sanctions, Iran has been ramping up its use of cryptocurrencies to get around them.
In narrow terms, the economic sanctions imposed by the United States on Iran in the last two years have been effective, shrinking the Iranian economy by 10 to 20 percent. But they have also accelerated Iran’s use of cryptocurrencies such as bitcoin, which are increasingly used by the Iranian government and public to evade legal barriers. This has led to an attempted crackdown on bitcoin by international regulators—but the cryptocurrency industry is proving more nimble than the enforcers of sanctions.
The Iranian government has long had an interest in using cryptocurrencies to support international trade outside of the traditional banking system. In July 2018, President Hassan Rouhani’s administration declared its intention of launching a national cryptocurrency; one month later, a news agency affiliated with the Central Bank of Iran outlined multiple features of the national cryptocurrency, stating that it would be backed by the rial—Iran’s national currency. Multiple blockchain projects—developing the underlying technology for cryptocurrencies—were revealed by the central bank at a digital payments conference last year, one of which is reportedly already being tested by four Iranian banks (three of which are under sanctions).
Cryptocurrency transactions are already popular with the Iranian public, according to various reports. In some interviews, people have described bitcoin as the only way to get money out of Iran. Cryptocurrency mining activity, which is a heavy computational process that generates, or “mines,” new cryptocurrency, is also significant in Iran. Lured by the cheap cost of electricity in the country, and the devaluation of the Iranian rial, several bitcoin miners set up operations in Iran in 2018. In 2019, a survey conducted with 1,650 Iranians using bitcoin showed that 25 percent of respondents made $500 to $3,000 per month working with cryptocurrency. The Iranian government also appears to have recognized the value in mining as an economic sector. In August 2019, after a month of harsh crackdowns on mining activity for abusing cheap electricity, the cabinet issued a regulation that recognized mining as a legal sector in the economy.
Interestingly, Iran also appears to have attracted interest from other countries willing to collaborate via blockchain platforms. In 2017, Sweden reportedly authorized a local start-up to invest in firms on the Iranian stock market by using bitcoin. In November 2018, Iranian and Russian blockchain industry personnel signed an agreement for cooperation in developing Iran’s blockchain industry, with a stated aim to address challenges arising from sanctions. In 2019, Iran’s Trade Promotion Organization conducted negotiations on the use of cryptocurrencies in financial transactions with representatives of eight countries, including Switzerland, South Africa, France, England, Russia, Austria, Germany, and Bosnia-Herzegovina. In 2016, as per the Iran nuclear deal, the United Nations and European Union lifted sanctions on Iran. The EU recently launched Instex, a transactions channel between Europe and Iran.
Multiple obstacles still exist, however, before Iran can fully harness the power of cryptocurrencies. The room for anonymity is steadily shrinking for cryptocurrency transactions as formal identification of customers through “know your customer” (KYC) compliance rises globally. In 2018, the U.S. Treasury Department’s Office of Foreign Assets Control added two Iranian individuals and their bitcoin addresses to its Specially Designated Nationals List. According to forensic analysis by the Treasury Department, more than 7,000 bitcoin transactions valuing millions of dollars had been processed by these addresses. Apart from other criminal activity such as the Silk Road case and numerous scams, cryptocurrency usage by regimes such as Venezuela and Iran has been one of the driving factors for heavy regulation of the sector.
Apart from country-specific regulations that mandate financial compliance, the Financial Action Task Force’s standards were set in 2019 and are now enforced across 37 member countries. These standards impose full KYC compliance at the level of virtual asset service providers, as well as a “travel rule” that requires both originators and beneficiaries of cryptocurrency transactions to identify and report suspicious information. These regulations effectively exclude Iran from major cryptocurrency exchanges. This has tilted the Iranian cryptomarket toward local exchanges, where price premiums on the currency are higher. Iran is thus losing out on its competitiveness in mining compared with other jurisdictions. While electricity costs are lower, other costs related to mining, such as hardware and operations, are much higher in Iran. Meanwhile, there is still regulatory uncertainty over the future of cryptocurrency within Iran.
Despite these challenges, there are new developments in the world of cryptocurrency that may open up new possibilities for the Iranian government and people to evade sanctions. One significant development is the rise of central bank digital currencies, which are the governmental take on cryptocurrencies—central banks issuing natively digital money. China and Russia have notably been working on these projects for some time, and the Chinese sovereign coin, or “digital yuan,” is expected to be launched this year. The implications for international sanctions are vast. First, these projects inevitably run on private blockchains that provide no traceability to outside countries the way a bitcoin network does. The second is that these instruments are completely outside the purview of current U.S.-led global financial architecture. Countries that are still open to cooperating with Iran could easily explore avenues through the use of such sovereign coins.
Another more significant industry-led development is decentralized finance. Popularly referred to as “DeFi,” this rising class of cryptocurrency projects aims to provide traditional financial services such as banking, lending, and trading over decentralized networks and without intermediaries. These expand significantly on the financial options available for ordinary citizens to services beyond just payments, which is what bitcoin currently offers. For example, Iran has been facing record-high inflation since 2019, but by using DeFi, Iranians can borrow from global markets at rates much lower than those inside Iran. Leveraging decentralized exchanges can also help the regime convert cryptocurrencies to fiat through channels that cannot be effectively controlled by outside regulators. The decentralized nature of these platforms makes them difficult to regulate as effectively as centralized exchanges.
DeFi still offers challenges for would-be sanctions evaders. These channels cannot offer very high liquidity as compared with large centralized cryptocurrency exchanges. The entire outstanding market cap for DeFi is estimated at around $430 million, and handling trades of $10 million to $20 million becomes challenging through these platforms. The Iranian regime might also deter access to DeFi for citizens by imposing harsh punishment, as it can pose a significant capital flight risk for the economy. On the industry side, the DeFi community leans heavily toward transparency, and all transactions are recorded in a blockchain, which can be subject to forensic analyses similar to bitcoin. Most service providers additionally undertake significant checks from their side to limit illicit activity through their platforms and avoid regulatory noncompliance.
Iran has clearly understood that cryptocurrencies are among the ways to challenge and subvert the U.S.-dominated financial architecture. Closing off these channels effectively will take global coordination and cooperation with cryptocurrency service providers; both global and Iranian regulations will determine the degree of access to these avenues. In the meantime, as long as holes in regulation exist, they are sure to be exploited by the Iranian regime and people.