As the US sanctions noose tightens around Russia’s ability to make and receive payments in dollars, Reuters reported for the first time that the major oil firms are increasingly turning to cryptocurrency to settle trade deals.

The volumes are still small in relative terms, but there are already hundreds of millions of dollars in trades and the use of cryptocurrencies that effectively sidestep all attempts to block Russia’s access to the international markets is only expected to rise.

The sixteen rounds of extreme sanctions on Russia have largely been ineffective with one major exception: getting paid for exported goods.

It started with the weaponisation of the dollar in the very first days of the war. Russia was barred from the SWIFT messaging service in the first week following the invasion of Ukraine in 2022. That effectively banned Russia from using the dollar, which was accounted for half (49.1%) of all international trade deal settlements as of August 2024 – a 12-year high. And as Russia’s main exports are commodities like oil, gas, grain and metal, all of which are almost exclusively traded in dollar-denominated markets, the impact of the loss of the dollar was even more painful.

Since then an entire industry of dodges and workarounds has sprung up to keep the cogs of commerce turning. Where it can, Russia settles its international trade bill using national currencies. That works well with China where the trade balance is even so both countries have use for each other’s yuan and rubles. But it doesn’t work with India, which has become Russia’s biggest buyer of oil that used to go to the EU; Russia imports little from India and has built up a $40bn trade surplus in rupees that it is struggling to spend.

In other cases, Russia has turned to alternative currencies like the UAE’s dirham, which is used in some oil trading, but this too is plagued by lack of liquidity issues and so offers only limited respite. In a related scheme, Russian companies that sell commodities to a dollar-paying customer then enter off-book informal currency markets where they sell their excess dollar earnings to other Russian companies that need them for imports.

Probably, the most popular way to dodge the sanctions is simply to use intermediaries, routine payments through multiple companies and jurisdictions to hide the origins and ultimate beneficiaries in a deal. But this takes time and drives up transaction costs that used to be negligible to several percentage points extra on any deal.

Then things got worse. At the end of 2023, the US switched tactics and introduced the so-called strangulation sanctions. Instead of generically targeting sectors and products, the Office of Foreign Assets Control (OFAC) that supervises sanctions began writing letters and targeting individual companies, banks and even tankers, threatening them with secondary sanctions if they did not cease and desist from doing business with Russians. This proved to be much more effective and in the spring of last year Turkish and Chinese banks pulled out of Russia due to fears of being hit by US secondary sanctions. Amongst them was the Chinese bank Chouzhou Commercial Bank that handled much of the trade with China, materially hurting the burgeoning Sino-Russian trade volumes.

Things went up a notch again at the end of last year, when the US imposed harshest financial sanctions yet, which has made it even more difficult for Russia to even use the yuan to settle trade deals, causing a yuan liquidity squeeze on Moscow’s own MOEX currency exchange.

That has left the Kremlin scrambling to find solutions and break the dollar’s stranglehold over the international settlements business as fast as it can.

That led to a series of emergency meetings at the Central Bank of Russia (CBR) at the start of 2024, where a rather panicked Vladimir Chistyukhin, first deputy governor, exclaimed that the only solution was to turn to cryptocurrencies, and the Kremlin spent the rest of the year rushing out a raft of legislation to underpin a digital ruble regime, culminating in the first tests of settling international trade deals using cryptocurrency in the summer and Russian President Vladimir Putin showcasing the BRICS Pay cryptocurrency at the BRICS summit in Kazakh in the autumn. But using cryptocurrency replace the dollar, even amongst willing friendly countries, is still years away.

Economic warfare and rise of shadow finance

In the meantime, the Kremlin has no choice but to continue to develop its shadow finance regime akin to the shadow fleet of tankers it has developed to avoid the oil price cap sanctions on oil exports.

Sanctions have long been wielded as a tool of economic warfare, designed to isolate countries from global financial systems and limit their ability to trade. The Western sanctions imposed on Russia following its invasion of Ukraine aimed to cripple its economy, yet, despite these measures, Russian trade did not collapse. Indeed, it flourished. Russia ran the biggest current account surplus of all-time in 2022 of over $250bn – twice the size of the previous record set only a year earlier in 2021. But the new strangulation sanctions are taking an increasing toll and that surplus shrank to $51bn in 2024, although it will likely stay at the same level this year.

According to a recent report by the Centre for Analysis and Strategies in Europe (CASE), Russian businesses have shifted much of their international trade to alternative settlement systems. Traditional banking transactions have become fraught with risk as Western financial institutions self-impose restrictions beyond legal mandates, avoiding any association with Russian-linked transactions.

“The increased complexity of international settlements caused by the sanctions has led to a surge in transaction costs for Russian businesses,” the report notes.

This has forced companies to turn to three primary methods for financial transactions: payments in rubles and "friendly" currencies, settlements in "unfriendly" currencies via intermediaries, and alternative systems including cryptocurrencies and informal networks.

By late 2024, an estimated 81.9% of Russian foreign trade was conducted in rubles or currencies from "friendly" nations, including China, Iran and Turkey. In trade with China alone, settlements in the yuan and ruble now account for 95% of transactions.

Whack-a-mole

International settlements have turned into a global game of whack-a-mole. OFAC has become adept at unearthing the Russian payment scams and closing them down. But Russia, and its partners in places like China, has become equally adept at working out new schemes to keep the money flowing. As new sanctions were imposed last year trade flows would dip, but it typically took a Russian firm about four months to work out a new scheme for getting paid and for the flows to recover to previous levels. Likewise, new sanctions on companies paying for Russian oil would see the discount Russia was forced to offer widen to $10-$15 a barrel for months, but as the new payment schemes came online those discounts would fall back to previous levels too.

While alternative financial systems have ensured that trade continues, they have come at a significant price. Transaction fees now exceed $10bn per year, while Russian businesses have been forced to divert an estimated $200bn into stockpiles and trade loans to mitigate supply chain disruptions, CASE repots.

This shift has also placed significant burdens on businesses. Executives who previously spent little time on financial transactions now dedicate up to 30% of their working hours navigating compliance hurdles and ensuring payments reach their destination. One Russian importer reported that a simple transaction that once took a day to complete can now take weeks.

The increased cost of compliance disproportionately affects small and medium-sized enterprises (SMEs), many of whom have opted to operate in the "grey economy" or cease foreign trade altogether. Large firms have adapted by developing multiple redundant payment systems, ensuring they can continue transactions even as new sanctions take effect. One large importer reported maintaining 14 independent settlement channels to avoid disruptions.

“For some businesses, foreign trade transactions now take 10 times longer to complete than before the war,” the report highlights.

The Role of China and the "Mirror" System

China has become the cornerstone of Russia’s new trade infrastructure. The CASE report outlines how Russian and Chinese firms have developed "mirror" and "mixer" mechanisms to obscure financial transactions from Western oversight. These involve parallel bank accounts in China and Russia that allow payments to circulate within each country’s financial system without triggering SWIFT-based alerts.

The mirror mechanisms have a long history in Russian finance and have been used to avoid multiple restrictions on certain transactions in the past. For example, in the early noughties foreigners could not buy the highly attractive locally traded Gazprom shares, so brokers set up parallel mirror schemes: a Russian entity bought local Gazprom shares, but a mirror proxy was available in London for dollars that exactly matched the value and size of the Russian package. An investor could buy the mirror proxy that gave de facto ownership of the local shares, but not de jure, as the investor never directly owned the shares and in this way foreign investors bought hundreds of millions of dollars’ worth of shares openly and legally.

“Western authorities have no access to the data on the transfer of rubles between the accounts, nor are they even aware that a certain Chinese company has a ruble account with a Russian bank.”

Even as US regulators attempt to tighten restrictions on Chinese banks suspected of facilitating Russian payments, the ability of businesses to shift to new intermediaries makes enforcement a problem. In particular, the threat of secondary sanctions on a Chinese bank only works if that bank has a branch in the US, but many of the smaller Chinese banks have purely domestic businesses, making them immune from the threats.

One of the report’s key findings is that Western sanctions may have reached the peak of their effectiveness. While they have undoubtedly have made business more expensive for Russian firms, they have also fuelled the expansion of alternative financial networks, which have become increasingly sophisticated as they cater to this new business and at the same time reduce the transparency of global trade.

A particularly stark comparison is made with US Prohibition (1919-1933), where efforts to ban alcohol led not to abstinence but to the rise of organised crime. Similarly, financial restrictions on Russia have not halted trade but have pushed it into the shadows, where it is harder to track and regulate.

“The assumption that sanctions can significantly reduce Russian foreign trade is as naive as believing that alcohol bans would turn millions of drinkers into teetotallers,” the report states.

Meanwhile, Western businesses have also been affected. European suppliers that once dealt directly with Russian buyers are now using third-party intermediaries, often at higher costs and with less oversight. In some cases, compliance departments of Western firms, seeking to avoid risk, have implemented stricter-than-required restrictions, inadvertently driving their own companies into inefficient workarounds. Big international players like Apple have closed all their Russian franchises down, but the iPhone is as available in Moscow stores as it was before the war; all that has happened is where Apple used to import some 25mn units a year directly, now the same phones traverse countries like Turkey via a plethora of smaller traders and the entire supply business has become opaque.

The Future of Sanctions: Rethink or Reinforce?

With Russia’s international trade turnover estimated at $600bn to $800bn annually, the idea that it could be isolated entirely now appears impossible. Russia’s market is too big to sanction and few multinationals are willing to give up so much business. As bne IntelliNews reported, less than 9% of international companies that were working in Russia pre-war have actually left, and of those that did, most are still using the traders to supply the market, but keeping this business at arm’s length.

The CASE report suggests that Western policymakers face a choice: either intensify enforcement, risking further entrenchment of illicit networks, or rethink their strategy by legalising and taxing certain transactions to regain some measure of control.

The latter approach mirrors how the US government ultimately abandoned Prohibition, replacing it with a regulated alcohol market that ensured tax revenues flowed to the state rather than criminal enterprises.

Whether Western leaders choose to double down on sanctions or adopt a more pragmatic approach remains to be seen. The new trump administration has suggested that some sanctions maybe lifted but has yet to make its plans clear. But as the past three years have demonstrated, financial isolation is far easier to legislate than to enforce.