Iran and cryptocurrencies: payment for weapons and risks

Executive Summary

Iran's use of cryptocurrencies to pay for weaponry creates systemic risks for the global financial market, marking any associated assets as toxic. This will inevitably lead to tightened regulation of DeFi and P2P platforms and will require Virtual Asset Service Providers (VASPs) to implement proactive, multi-layered AML-systems, and users to exercise increased caution to protect their funds. The key recommendation for business is a shift from reactive compliance to proactive risk management through automated screening, clear escalation policies, and regular security system testing.

1. Introduction

Goal of the article — to conduct a comprehensive analysis of the risks associated with Iran's use of cryptocurrencies to circumvent international sanctions and finance the military-industrial complex. The statement by Mindex (the export arm of Iran's Ministry of Defense) regarding its readiness to accept digital assets as payment for armaments [¹] moves cryptocurrencies into the sphere of geopolitical confrontation.

Methodology — includes the analysis of technical anonymization mechanisms, the study of legal precedents, assessment of risks for market participants, and the development of practical recommendations.

Audience — the material is intended for regulators, VASPs, compliance specialists, institutional investors, and retail users.

2. Context: Sanctions and Cryptocurrency Adaptation

Iran is subject to over 4,000 sanctions from the US and its allies (according to the Atlantic Council as of early 2023 [²]), making its economy one of the most isolated. According to Chainalysis estimates, between 2020 and 2023, Iranian services processed cryptocurrency transactions worth over $10 billion, a significant portion of which is related to bypassing trade embargos [³]. The public statement by Mindex creates direct threats to the entire crypto industry.

August 8, 2022: OFAC adds the cryptocurrency mixer Tornado Cash to the sanctions list, creating a precedent for the prosecution of anonymization technologies [⁴].

August 23, 2023: Financial Times publishes a report on Mindex's readiness to accept cryptocurrency.

3. Technical Methods of Bypassing Sanctions

To hide the origin of funds, multi-stage schemes are used, complicating on-chain analysis.

Main Tools:

• Liquid Assets: Bitcoin (BTC) and Tether (USDT) on the Tron network (TRC-20) due to speed and low fees.
• Mixers: Services like Tornado Cash mix assets, breaking the direct on-chain link.
• Chain Hopping: Transferring assets between blockchains via cross-chain bridges. This scheme is a hypothetical example for illustration and is used in reality for large sums due to its complexity: USDT (ERC-20) is transferred via a bridge (e.g., Stargate) to the Polygon network, exchanged on a DEX for Monero (XMR), and withdrawn to an anonymous wallet.
• Privacy Coins: Monero (XMR) uses ring signatures and stealth addresses to anonymize transactions at the protocol level.
• Unlicensed VASPs: Exchangers and OTC platforms in jurisdictions with weak AML/CFT controls.

4. Monetization Paths: From Crypto to Fiat

The ultimate goal is the conversion of cryptocurrency into fiat money or goods.

• OTC Platforms: Unregulated over-the-counter platforms for exchanging large volumes with minimal verification.
• Local Exchangers: Physical and online exchangers in jurisdictions with lenient regulation (e.g., in some countries in the Middle East and Southeast Asia).
• P2P Platforms: Platforms like Binance P2P or Paxful are used to exchange "dirty" assets for fiat through bank transfers from uninvolved counterparties.
• Mining: Purchasing equipment with cryptocurrency allows for the legalization of funds. Mined coins are considered "clean" as their first owner is the miner.

Table: Sanctions Evasion Tools and Countermeasures

Evasion Tool	Risks and Consequences	Countermeasure Recommendations (for VASPs)
Cryptocurrency Mixers	Direct link to sanctioned addresses, high risk score	Automatic blocking of transactions coming from or going to mixer addresses.
Chain Hopping	Difficulty in tracking, break in the transaction chain	Use of advanced analytical tools that track cross-chain flows.
Privacy Coins (XMR)	Total or partial inability to trace the source	Prohibition of deposits and trading of privacy coins (delisting) or implementation of protocols like Monero’s View Key for verification.
P2P Platforms	Risk of receiving funds from money mules	Enhanced Due Diligence for P2P merchants, volume limits, selective screening of counterparty addresses.

5. Regulatory Response and Legal Risks

Transactions with Mindex violate sanctions regimes administered by the Office of Foreign Assets Control (OFAC) of the US Treasury Department.

Legal Basis: Acts such as the International Emergency Economic Powers Act (IEEPA) prohibit transactions with sanctioned persons.

Secondary Sanctions: Any person (regardless of jurisdiction) facilitating a "significant transaction" with a sanctioned entity risks being added to the SDN (Specially Designated Nationals) list.

Application Nuances: The application of secondary sanctions is not automatic. OFAC evaluates many factors, including the size, frequency, nature of transactions, and the degree of participant awareness. Enforcement in the EU is similar but often more restrained and depends on the consensus of member states. There are known cases where companies successfully challenged their inclusion in the SDN list by proving lack of intent or the insignificance of violations; however, such processes are complex and costly.

Fines and Prosecution: Violations lead to fines (Kraken — $362k, Bittrex — $29m [⁵]) and criminal prosecution (arrest of the Tornado Cash developer).

6. Scenario Risk Analysis and Quantitative Assessment

Scenario	Probability	Estimated Business Impact	Consequences
1. Low Risk (Retail User)	High	Low (up to $1,000)	Receiving USDT via P2P linked to a sanctioned address through 3–4 "hops". Consequences: temporary deposit block on CEX, Source of Funds request.
2. Medium Risk (VASP/Fund)	Medium	Medium (fine up to 5% of annual turnover)	Accepting a large deposit where the AML system failed to track the link to Mindex. Consequences: regulatory inquiry, fine, reputational damage, loss of banking partners.
3. High Risk (Deliberate Facilitation)	Low	Critical (total loss of business)	OTC platform consciously helps convert assets from Mindex. Consequences: inclusion in the SDN list, asset seizure, criminal prosecution.

7. Practical Risk Management Recommendations

For Private Users

1. Asset Isolation: Upon receiving suspicious funds, immediately transfer them to a separate "quarantine" wallet. Do not top it up with "clean" assets.
2. Avoid CEX: Do not send potentially "dirty" funds to centralized exchanges.
3. Conduct AML Analysis: Use AML services to assess the risk of assets before interacting with them.

For Business (VASPs and Funds)

1. Set AML/CFT Policy and Escalation Thresholds:

   • Threshold Policy:
     Risk score < 50: automatic approval.
     Risk 50–79: manual review.
     Risk > 80: automatic block and escalation to the compliance officer.

   • Escalation Process:
     Automatic alert → transaction freeze → request documents from client → investigation → decision (unblock / file SAR / account closure).

2. Implement Automated Screening: Use AML solutions (Chainalysis, TRM Labs) to check all transactions in real-time.

3. Develop an Incident Response Plan: Define the algorithm of actions upon detecting a high-risk transaction.

   Brief SAR (Suspicious Activity Report) Template:

   1. Subject ID: [Client ID]
   2. Transaction Hashes (TXID): [List of TXIDs]
   3. Addresses: [Sender/Receiver Addresses]
   4. Amount and Asset: [e.g., 10,000 USDT]
   5. Description of Suspicious Activity: [e.g., link to OFAC sanctioned address via 3 hops, risk source — Darknet Marketplace]
   6. AML Check Results: [Risk score 95/100]
   

4. Resource Assessment:

   • Small Exchanger: Can use basic APIs from AML providers and manual checks for transactions above a certain threshold (e.g., $1,000).
   • Large CEX: Requires full integration with several AML providers, a staff of compliance analysts, and an automated case management system.

8. Metrics and Testing of AML Systems

To evaluate the effectiveness of AML procedures, it is necessary to implement key performance indicators (KPIs) and conduct regular testing.

Key Metrics:

• False Positive Rate: Percentage of legitimate transactions mistakenly flagged as suspicious. A high rate overloads the compliance department.
• Mean Time to Investigate (MTTI): Time from receiving an alert to making a decision.
• Percentage of Transactions Requiring Manual Review: Shows the effectiveness of automated rules.

Examples of Test Scenarios:

• Scenario 1 ("Dust" Deposit): Sending a small amount of BTC to a test account from an address linked to a mixer via 5–6 "hops". The system should assign the transaction a medium or high risk score.
• Scenario 2 (Structuring): Several deposits below the KYC threshold from different addresses linked to a single high-risk source. The system should identify this as a structuring attempt.

9. Operational Constraints and Balance of Opinions

Effective counteraction is complicated by several factors:

• International Coordination Challenges: Differences in legislation and priorities hinder the rapid exchange of intelligence between jurisdictions.
• Attribution Issues: On-chain analysis cannot always prove address ownership by a specific person with 100% certainty, creating legal difficulties.

Meanwhile, the crypto community maintains the view that blockchain is a neutral technology, whose key value is censorship resistance.

10. Conclusion

Iran's use of cryptocurrencies in military settlements indicates a new role for digital assets in geopolitics. This precedent will accelerate the development of on-chain analysis technologies and the tightening of regulations. For market participants, this means the necessity of shifting from formal rule compliance to creating a tiered risk management system. Integration of deep AML checks, clear internal procedures, and regular testing is becoming a basic requirement for sustainable operation in the new legal landscape.

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Sources and Notes:

1. Financial Times, "Iran’s defence ministry to accept crypto for weapons payments", August 23, 2023.
2. Atlantic Council, "Future of Iran Sanctions", January 25, 2023.
3. Chainalysis, "2024 Crypto Crime Report" (data aggregated and may include estimates).
4. U.S. Department of the Treasury, "U.S. Treasury Sanctions Notorious Virtual Currency Mixer Tornado Cash", August 8, 2022.
5. U.S. Department of the Treasury, press releases on settlements with Bittrex, Inc. (October 11, 2022) and Kraken (November 28, 2022).