How to Identify Sanctioned Cryptocurrency Wallets

| by sasmatipati@gmail.com

Last Updated on: 19th September 2023, 07:10 pm

How to Identify Sanctioned Cryptocurrency Wallets

Cryptocurrencies like Bitcoin and Ethereum have exploded in popularity in recent years. But with greater adoption comes greater government regulation. Regulators around the world are increasingly looking to restrict certain crypto wallets and addresses associated with sanctioned individuals or entities. So as a crypto user or business, it’s crucial to understand how to identify potentially sanctioned wallets so you don’t accidentally break the law.

In this guide, I’ll walk through everything you need to know about spotting sanctioned cryptocurrency wallets. I’ll cover:

What Are Sanctions and How Do They Apply to Crypto?

Economic and trade sanctions are restrictions put in place by governments to block transactions and freeze assets of certain countries, companies, organizations and people. They allow countries to apply economic pressure without having to use military force.

In the US, the main agency enforcing sanctions is the Office of Foreign Assets Control (OFAC), which operates under the Department of the Treasury¹. OFAC maintains a list of Specially Designated Nationals (SDNs) who are subject to blocking sanctions. This means all property and assets belonging to SDNs must be blocked and reported to OFAC.

While sanctions have traditionally focused on the mainstream financial system, cryptocurrencies have opened up potential loopholes. To close these, OFAC has started adding crypto addresses to the SDN list associated with sanctioned people and organizations. Transacting with those addresses could violate sanctions.

How to Use Sanctions Screening Tools

Luckily, there are several handy tools available to screen crypto addresses against sanctions lists like OFAC’s SDN list. This allows you to catch any potential matches before making a transaction.

Here are some top options:

• Chainalysis Oracle: This free on-chain tool can be integrated directly into smart contracts to check sanction status for various major cryptocurrencies.²
• Chainalysis API: The Chainalysis API lets developers build custom sanctions screening into crypto apps and services. It supports screening for OFAC and other major lists.³
• Elliptic: Elliptic provides crypto transaction monitoring to detect sanctioned activity across major cryptocurrencies.⁴
• CipherTrace: CipherTrace offers wallet screening and blockchain forensics to check for sanctions violations.⁵

The right solution depends on your needs. Developers may prefer Chainalysis’ on-chain tool, while exchanges likely require robust API capabilities.

Checking the OFAC SDN List

In addition to screening tools, you can manually check addresses against the OFAC SDN list. This list contains individuals and companies subject to various sanctions programs and is updated frequently.

OFAC indicates crypto addresses associated with SDNs in the “Remarks” column for each entry. You can download the full SDN list as a CSV file for easy searching.⁶

For example, in 2022 OFAC designated several Russian crypto addresses linked to harmful cyber activities. The “Remarks” showed they were “Digital Currency” entries.⁷

Also check OFAC’s FAQ page on virtual currencies for guidance on identifying and reporting sanctioned crypto wallets.⁸

Analyzing On-Chain Activity

In addition to specific addresses, analyzing the on-chain activity associated with a wallet can provide valuable insights into potential sanctions risk.

Some suspicious transaction patterns include:⁹

• Interacting with OFAC-sanctioned addresses
• Using mixers and tumblers to obscure transaction source
• Links to darknet markets or other illegal activity
• Flow of funds to/from sanctioned jurisdictions
• Connections to wallets engaged in suspicious activity

Advanced blockchain analytics tools use machine learning to detect high-risk transaction patterns across the blockchain.

Assessing Contextual Risk Factors

In addition to on-chain activity, consider these contextual risk factors when evaluating sanctions risk:

• Location: Is the wallet owner based in a sanctioned country?
• Ownership: Is the wallet tied to a sanctioned entity?
• Activity: Is the wallet used for transactions in sanctioned sectors or countries?
• Connections: Does network analysis reveal links to other sanctioned wallets?

The more risk factors that apply, the higher the chance a wallet could be sanctioned. This can lead to legal penalties, reputational damage, and requirements to freeze or restrict transactions.

If screening tools or the SDN list show a potential match, avoid transacting with the wallet until you conduct further due diligence. A few key next steps include:

• Carefully review the match to determine if it is a valid hit or a false positive. Check for slight name variations, misspellings, etc. Consult OFAC’s guidance on assessing name matches.¹
• For transactions in progress, contact OFAC compliance right away. They will advise if the transaction should be blocked or rejected while investigating further.²
• Review your sanctions screening software configuration and logic. False positives can signal issues with name matching thresholds.³
• Conduct enhanced due diligence into the wallet owner’s background, location, activity, ownership structure, etc. to determine sanctions risk.⁴
• If it is a valid match, block or reject the transaction and file a report with OFAC within 10 days.
• Consider restricting transactions from the wallet pending investigation.
• Review historical activity associated with the wallet for other potential violations.
• Update sanctions screening software and procedures as needed to avoid future false positives or misses.

The key is not to assume all matches are prohibited parties, but also not to dismiss them without proper due diligence. Document your investigation and risk analysis thoroughly. OFAC looks for evidence of good faith efforts to comply.

By combining screening tools with robust processes to investigate alerts, you can avoid inadvertent sanctions violations while allowing legitimate activity to proceed.