On a daily basis, people see ‘live’ why the sanctions against Russia matter. Everyone now appears to rethink the importance of compliance and cryptocurrency. Whose side are you on? It seems like the Ukraine-Russia way is forcing people to answer this question.
For some participants in the crypto community, it could be uncomfortable since in case an individual or project stands with the West against Russia, it also means that the project abides by sanctions. It can be complex and challenging to square with crypto/blockchain’s alleged decentralized system and its allegations on being borderless, distributed, and censorship-free.
Take OpenSea, for instance, the NFT marketplace is not a decentralized project but is mostly described as such. According to CoinMarketCap:
“OpenSea is a decentralized peer-to-peer marketplace for buying, selling and trading rare digital goods.”
However, when OpenSea recently banned Iranian users from using its nonfungible token trading platform, insisting that it was just abiding by the United States sanctions law, it provoked a lot of outrage among some of the NFT collectors. In that context, documentary photographer Khashayar Sharifaee tweeted:
— Khashayar sharifaee (@sharifaee) March 3, 2022
This now raises the question: OpenSea incensed a majority in its community by banning Iranian users, but did it have a choice? Are the general public and government officials more keenly looking at crypto regulation, mostly with the outbreak of the Russia-Ukraine war?
Moreover, while the huge United States-based crypto-related firms like OpenSea, FTX, Consensys, and Coinbase must abide by the US regulations and sanctions, what about the decentralized projects without any easily defined headquarters, nation affiliations, or leaders? Will they or can they comply, too, or will they get a pass?
Eventually, there is a long-term question: will we ever have a wholly-functional decentralized marketplace? Won’t the entire cryptoverse inevitably have to compromise somehow with centralized institutions like the sovereign governments?
Increased Regulatory Attention
CEO of Swan.com, Cory Klippsten, when asked about recent events happening in the world, said:
“Governmental authorities have definitely taken more interest in crypto-regulation as of late. Serious regulatory discussions have been ongoing for many years now. Still, the Russia-Ukraine War has pushed crypto into the spotlight, which is why we are seeing more public interest concerning these crypto-regulatory developments.”
The founder and CEO of Securitize, Carlos Domingo, agreed:
“Everyone is starting to rethink the importance of compliance and crypto for a number of reasons. We are seeing live, right now, the importance and effectiveness of sanctions in connection with the war.”
US regulators are increasing pressure on the largest players in the crypto world to comply with rules and regulations. Markus Hammer, an attorney, and principal at Hammer Execution consulting company said:
“And now, also, somewhat decentralized crypto platforms.”
That might be the reason why OpenSea came down quite hard on Iranian users in the past week, although Iranian sanctions were re-imposed in 2021. Klippsten commented on this issue:
“As regulations appear to be imminent, companies like OpenSea are trying to protect themselves by ensuring they’re compliant with any potential regulations coming down the pipeline. That’s why you’re seeing them ban Iranians.”
Will we begin to see more projects like FTX or Binance that were previously vague about their geographic headquarters become clear on where they are now based? Just like OpenSea did last week, will others declare?
“We’re a U.S.-based company that must comply with U.S. sanctions law?”
We’re truly sorry to the artists & creators that are impacted, but OpenSea is subject to strict policies around sanctions law. We're a US-based company and comply with US sanctions law, meaning we're required to block people in places on the US sanctions lists from using OpenSea
— OpenSea (@opensea) March 3, 2022
“I’m not sure that OpenSea tried to hide their location. Most people knew that the CEO and other employees were based in New York. For the record, I don’t see OpenSea as a decentralized project at all. I think it is pretty centralized, similar to Coinbase, Binance, and FTX.”
“Rather, what we are seeing now is that increasingly regulators care about fraud and illegal activities committed against their citizens and businesses, and they are increasingly willing to pursue enforcement action anywhere in the world, such as in the case of BitMEX.”
However, many in the cryptocurrency community see a lot of betrayal in OpenSea’s actions, since blockchain-based projects are supposed to be censorship-free. Is it fair that an Iranian artist who does not have anything to do with the government’s action is denied a platform to sell their digital art?
“OpenSea has to comply with U.S. sanctions rules and laws like any other centralized U.S.-based company. By contrast, a decentralized project like Bitcoin has no leader and is truly permissionless. It’s impossible to ban users or comply with sanctions when no one can unilaterally control the project.”
It does not make anything easy that there are various sorts of sanctions regimes. These sanctions were imposed by the US against Russia, for instance, are targeted. They do not apply to ordinary Russians. Instead, they target financial sectors and Russian elites, including the oligarchs. On the contrary, the US Iranian sanctions affect all the users that are based in Iran.
Parties are also allowed to differ in their interpretations of these sanctions. For instance, one Iranian artist Arefeh Norouzii, was “de-platformed” by OpenSea, although an Iranian citizen “is not even domiciled in Iran,” said Hammer.
“In that case, I would argue the legal basis for OpenSea’s decision to deplatform Arefeh based on their terms is not in line with the relevant sanctions.”
“OpenSea would be committing a crime by processing transactions from people living in Iran, and it’s as simple as that. I know it seems unfair that people in sanctioned countries are impacted in this way since they are not responsible for their governments’ actions, but this is what the U.S. government has decided is the best way to protect its citizens and interests.”
Given the recent events, it is fair to say that some of the entities in the crypto and NFT world are not as decentralized as they allege to be. A professor in the business and economics department at the University of Basel, Fabian Schär, insisted:
“Some infrastructure services are more centralized than they may seem at first glance.”
Although these users have other options available even if projects are not entirely decentralized, they can just run their full node and use alternative user interfaces. Hammer believes that some of these somehow decentralized platforms did not consider the existing financial market regulations until recently.
“They thought themselves in the supposedly safe ‘decentralized’ space and never considered that over time they might get caught up in market regulation of the traditional financial world. It’s catching up with them now, however, particularly crypto exchanges with fiat ramps.”
Will DEXs Comply?
The question comes: What about the decentralized projects? Are they untouchable from a compliance and regulatory point of view? Or, given that there is some great compliance software to identify all the “bad actors” on decentralized digital ledgers today, isn’t it possible for DEXs and many other decentralized projects to comply entirely in case they want to do so?
“The tools are there and they are getting stronger and more and more effective.”
A great example is the way Chainalysis’ forensic tools were utilized recently to determine the malefactor behind the infamous 2016 hack of The DAO. Domingo also said:
“It’s very easy for companies to comply with regulations if they want to. There is no lack of tools or technology and, in fact, it seems that some ‘decentralized’ projects are already doing this.”
“Software solutions do exist and any party that bridges between traditional finance and decentralized finance is required to be compliant with Anti-Money Laundering regulation and the sanction lists.”
Since the whole business model depends on access to the traditional payment systems, Schär does not believe that they will put the access at risk. On the contrary, decentralized exchanges are just some smart contracts that offer neutral infrastructure.
“A smart contract cannot run these checks. However, we also have to be aware that these decentralized exchanges have no access to traditional finance. All you can do is swap tokens.”
As a result, the risks that come with DEX’s are smaller than the ones presented by the centralized exchanges. Some of the entities will play regulatory arbitrage as long as they can manage. However, this is a shortsighted strategy sine although technology moves faster than regulation, eventually, the regulation will catch up.
But in general, the big question remains: Will we ever have a truly decentralized marketplace?
“There are some truly decentralized marketplaces. A non-upgradable constant function market maker is one example. There are no special privileges, no external dependencies and no one in charge who could even make these decisions.”
These types of projects are normally up and running forever since they can never be regulated directly. For this reason, the policymakers and regulators need to focus on the on- and off-ramps and utilize indirect regulation, according to Schär.
While decentralization is achievable provided that an organization follows two principles: It deploys an open-source code and is mainly governed by a decentralized autonomous organization (DAO).
But, maybe there will always be some limitations on the behavior even among the decentralized entities and most of the projects will inevitably have to somehow compromise with the centralized institutions including sovereign governments.
“Yes, that is how I see it. Finance will continue to become increasingly decentralized, but adoption will require safeguards to protect investors from scams and bad actors. We will eventually reach some sort of middle ground.”