Crypto's Invisible Bridges: How Crypto Assets Challenge Global Capital Controls

Introduction:

Capital Flow Measures (CFMs) are policies implemented by governments to regulate the movement of capital in and out of a country. As cryptocurrencies and blockchain technology have evolved, they present new challenges to these traditional financial controls. This article explores how crypto assets are being used to bypass CFMs, focusing on two main types of measures and providing real-world examples.

Currency Exchange Restrictions:

These measures aim to restrict or limit the exchange of a local currency into foreign currencies, or the conversion of foreign currencies into the local currency, and subsequent transfer of capital across borders. For example, a country might limit the amount of foreign currency its citizens can purchase annually.

Cross-Border Asset Transfer Restrictions:

These measures restrict or limit the terms and conditions of holding, trading, and transferring assets across borders. This could include regulations on foreign investment, limits on overseas property purchases, or restrictions on moving large sums of money across borders.

Cryptocurrency Structures Used to Circumvent CFMs:

Mixers and Tumblers:

Crypto mixers, also known as tumblers, are services designed to obscure the trail of cryptocurrency transactions. They pool funds from multiple users, mix them, and then redistribute them, and then redistributing them. This process makes it extremely difficult to trace the origin of the funds.

In 2023, the U.S. Treasury sanctioned Sinbad, a mixing service primarily used by North Korean hackers to launder stolen cryptocurrency. Sinbad was reportedly used to process millions of dollars’ worth of virtual currency from hacks attributed to the Lazarus Group.

Tokenized Assets:

Tokenization involves creating a digital representation of a real-world asset on a blockchain. This allows for the fractional ownership and easy transfer of assets that might otherwise be subject to strict regulations.

A property owner in a country with strict capital controls could tokenize their real estate and sell these tokens to foreign investors. Investors effectively own a portion of the property without directly purchasing foreign real estate, potentially bypassing restrictions on foreign property ownership.

Off Ramp – On Ramp structure:

A user converts their local currency into a crypto asset like Bitcoin or a stablecoin pegged to a foreign currency through online exchanges or platforms. The crypto asset is then securely transferred across borders and exchanged into the desired foreign currency, such as US dollars, using local or global exchanges. The funds can then be deposited into a foreign bank account or invested in other assets. Crypto exchanges may need traditional bank accounts to process local currency transactions.

However central banks and foreign exchange regulators may not have the authority or visibility to block these transactions. Additionally, crypto exchanges can hold local currency proceeds in mobile money accounts or stablecoins, especially for smaller transactions, further complicating regulatory efforts.

Cross Border SPVs Structure:

Country A has CFM restrictions in place. An investor in Country A wants to move assets abroad.

1. Structure:

SPV 1 is established in Country A (the restricted country). SPV 2 is established in a foreign country (unrestricted). The investor transfers assets to SPV 1 in Country A, and SPV 2 buys shares of SPV 1, effectively gaining control over SPV 1 and its assets.

2. Leverage:

Based on the equity value of SPV 2 (which is backed by the assets in SPV 1), SPV 2 borrows stable coins. These borrowed stable coins are then paid to SPV 1 as payment for its assets..

Peer-to-Peer (P2P) Platforms:

P2P crypto trading platforms allow users to buy and sell cryptocurrencies directly with each other, often using local payment methods. This can facilitate the movement of value across borders without triggering traditional banking alerts.

In Nigeria, where there are limits on foreign currency purchases, P2P platforms have become popular for obtaining US dollars through cryptocurrency transactions.

Synthetic Assets:

Synthetic assets, also known as synths, are derivative crypto tokens that mimic the value of other assets without requiring direct ownership of those assets. These can represent a wide range of financial instruments, including stocks, commodities, currencies, or even other cryptocurrencies. They can be used to gain exposure to foreign assets or currencies that might otherwise be restricted.

1. Structure of Synthetic Assets:

Synthetic assets are typically created using smart contracts on blockchain platforms like Ethereum. They are often overcollateralized with cryptocurrency to ensure stability and manage risk. Price feeds from oracles are used to track the value of the underlying asset and adjust the synthetic asset's price accordingly. The synthetic asset exists as a token on the blockchain, which can be traded, transferred, or used in other DeFi applications.

2. How Synthetic Assets Can Be Used to Bypass CFMs:

2.1 Access to Restricted Markets:

In countries where certain foreign investments are restricted, synthetic assets can provide exposure to those markets without directly purchasing the underlying assets. A user in a country that restricts foreign stock ownership could buy a synthetic token representing shares of a major U.S. tech company, gaining price exposure without owning the stock.

2.2 Currency Exposure:

Synthetic assets can provide exposure to foreign currencies in countries with strict exchange controls. In a country with limits on USD purchases, users could buy synthetic USD tokens to hedge against local currency devaluation or speculate on forex markets.

2.3 Commodity Exposure:

Users can gain exposure to global commodities that might be difficult to access due to CFMs. An investor could buy synthetic gold tokens to diversify their portfolio without the need to physically purchase and store gold or navigate import restrictions.

2.4 Fractional Ownership:

Synthetic assets allow for fractional ownership of high-value assets that might otherwise be inaccessible due to capital controls.

2.5 Leverage and Short Selling:

Some synthetic asset platforms allow users to take leveraged positions or short sell assets, which might be restricted in traditional markets due to CFMs.

2.6 Privacy and Pseudonymity:

Transactions in synthetic assets can potentially offer more privacy than traditional financial systems, making it harder for authorities to track capital flows.

Conclusion:

Crypto assets offer a novel and challenging avenue for circumventing capital flow controls. Their decentralized, anonymous, and global nature makes them an attractive option for individuals and entities seeking to bypass traditional regulatory frameworks. While some countries have begun to adapt their regulations, effective management of crypto assets in the context of CFMs will likely require international cooperation and innovative regulatory approaches. As the crypto ecosystem continues to evolve, so must the strategies for ensuring financial stability and regulatory compliance.