Ofac's crypto blacklist could drive investors to riskier exchanges

Author: Olly Jackson | Published: 6 Apr 2018
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The US Treasury’s Office of Foreign Assets Control's (Ofac) decision to blacklist cryptocurrency addresses could backfire and drive investors to smaller, less transparent exchanges.

The agency's new March 19 guidance adding digital currencies to the Specially Designated Nationals and Blocked Persons List (SDN) in the same way as fiat currencies is intended to reduce money laundering and fraud. But this decision could lead investors to riskier exchanges. 

Bitcoin1The SDN list includes individuals, groups and companies owned by targeted countries or acting on behalf of targeted countries, named specially designated nationals. Their assets are blocked and US persons are generally prohibited from dealing with them. The list also includes individuals, groups and entities designated under programmes that are not necessarily country-specific. This is widely expected have wide repercussions for exchanges and the cryptocurrency sector itself. Blackrock chief executive Larry Fink previously branded bitcoin an index of money laundering. 

Going underground

The changes are yet another layer of regulatory scrutiny that cryptocurrency exchanges will have to navigate. This could, however, go against the regulators’ aim of providing more investor protection. 

"People may not use the prominent exchanges and could go underground where the investor risks are even greater," said Linklaters partner Doug Davison.

The Ofac guidance presents yet another hurdle for US exchanges to address. This new development is particularly onerous because the SDN list is updated constantly, requiring exchanges to frequently check the list to see if any of their investors are included. This is a daunting task, particularly for start-ups, which may already have to file with the Securities and Exchange Commission (SEC). 

For many crypto-zealots, who tend to be very strong advocates of privacy and banking away from state intervention, this could drive them to less well-known cryptocurrencies that offer greater privacy or to smaller exchanges that exist outside of regulation. Most of the established exchanges are said to already comply with much of the regulation enforced by the various bodies that have stepped in - the SEC, the Commodity Futures Trading Commission (CFTC) and the IRS to name a few  - but smaller ones are less likely to do so.      

The SEC has been on an aggressive enforcement surge this year, penalising several cryptocurrency exchanges for not registering with the regulator. Last month, the CFTC was granted legal permission by a district court judge to regulate cryptocurrencies as commodities. As a result, exchanges potentially have to comply with commodities regulation, securities regulation and also rules from state regulators.

Because of this confusion, IFLR has been told that many exchanges are shunning the US because of the lack of clarity. For initial coin offerings (ICOs) open to US investors, the majority of exchanges are automatically registering with the SEC even though they may not need to. Whether a company needs to register with the SEC depends on if they are offering digital tokens – those that have their own, exclusive, underlying blockchain. Exchanges that only offer bitcoin or alt-coins – those that are issued on a bitcoin derived blockchain – currently do not need to register with the SEC, but this could be subject to change after the financial regulator finalises its investigation into the sector.


  • Ofac has said cryptocurrency addresses will be added to SDN lists, meaning that exchanges will need to constantly look at the list to ensure investors are not on there;
  • But this could lead to investors switching to less transparent exchanges where the investor risks are greater. The change could be counter-productive to the regulators’ aims;
  • In Europe, to combat money laundering, watchdogs have extended existing AML rules to cover cryptocurrencies.

Where does the market stand now?

This confusing regulatory outlook is unlikely to change soon. It's expected there will be more actions by the state regulators and the SEC will work alongside them. But as the SEC expands its investigations, current regulation could be changed again, particularly on ICOs that are said to be flouting securities laws.

"Given the enormous growth in the crypto market, the SEC is almost playing wack-a-mole trying to regulate the cryptocurrency sector," Davison said. "As the market keeps changing they want to be flexible with it and each regulator is trying to apply existing terms of work."

"The changes are yet another layer of regulatory scrutiny that cryptocurrency exchanges will have to navigate"

As well as the decision to include cryptocurrencies under the SDN list, the US Treasury said it was planning to review the Financial Crimes Enforcement Network cryptocurrency practices relating to money laundering and terrorism financing risks.     

"Regulatory bodies are going to work more closely together," said Orrick counsel Jason Somensatto. "We could potentially see one body taking most of the responsibility in the future, but which body depends on the legal definition."

The EU has extended the fourth AML directive to include cryptocurrencies, meaning that exchanges and wallet providers must comply with the directive just as a conventional financial platform would. In Europe, much of the existing rules on conventional financial instruments have been extended to include cryptocurrencies and it appears that the US will follow in the same direction.

But the risk in implementing greater regulation for a sector that was established precisely because it wanted to avoid regulation, is that investors will look elsewhere. There will be no shortage of alternative options that aim to avoid regulatory oversight.

See also

Confusion reigns: are cryptocurrencies commodities or securities?

EU can look to US, Swiss approaches for crypto regulation

France’s crypto derivatives rules could be EU template