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US officials have highlighted Tether’s alleged role in Russian sanctions busting, as regulators seek new powers to enforce secondary sanctions against offshore crypto firms.

Last week, during a Senate Banking Committee , Tether was named multiple times in relation to sanctions busting by Russia and other states and terrorist groups.

The hearing focused on countering illicit finance and sanctions evasion, and served as a platform for the Treasury to reiterate its call for new powers to go after sanctions evaders.

“Our problem is that actors are increasingly finding ways to hide their identities and move resources using virtual currency,” said Wally Adeyemo, deputy secretary of the Treasury. 

“What has always been true is that terrorists and other malign actors seek new ways to move their resources in light of the actions we are taking to cut them off from the traditional financial system.”

Adeyemo specifically named Tether as an example of an “alternative payment mechanism” that Russia is now using to “circumvent our sanctions and finance its war machine”.

Senator Sherrod Brown (R-OH), the committee chair, made similar comments during his .

“All these bad actors — from North Korea to Russia to terrorist groups like Hamas — aren’t turning to crypto because they’ve seen the ads and bought the hype,” said Brown.

“They’re using it because they know it’s a workaround. They know that it’s easier to move money in the shadows without safeguards, like know-your-customer rules or suspicious transaction reporting.”

How is Tether used in Russia's arms trade?

Both Adeyemo and Brown referred to a Wall Street Journal (WSJ) published this month, which looked at how Russian arms dealers are using Tether to purchase dual-use military equipment from overseas.

The article is based primarily on interviews with Andrey Zverev, who works as a buyer for Kalashnikov Concern, maker of the AK-47 and other weapons such as drones.

Zverev said he was happy to talk about Tether’s role in the arms trade as neither he nor his company are breaking any laws in Russia by using it.

He also noted that Kalashnikov has been sanctioned since 2014, following Russia’s annexation of Crimea.

As described by Zverev, when using Tether, Russian buyers that need to pay suppliers in Hong Kong, China or the Middle East will first transfer their roubles to a Russian bank account holder.

This account holder will then use a Russian crypto exchange, such as Garantex, which was sanctioned by the US Treasury in 2022, to convert the roubles to Tether.

The Tether is then sent to an agent of the supplier, who uses a crypto exchange or an over-the-counter broker to convert the Tether into local currency.

The local currency is then wired to its final destination with the supplier using a local bank transfer.

In Zverev’s words, Tether is used to “break up the connection” between buyer and seller, making it harder for Western governments to trace the transactions. “USDT is a key step in the chain,” he said.

As noted by Brown, when Tether is converted into fiat currency using offshore exchanges and money changers, it exposes the US financial system to lack of sanctions screening and KYC controls.

“These common-sense protections help identify illicit money and keep it out of the financial system,” he said.

“We must make sure that crypto platforms play by the same rules as other financial institutions. And we need to make sure that we have the tools to crack down on illicit finance with digital assets, just as we would with any other asset.”

Secondary sanctions could work

Tether’s role in Russia’s arms trade is likely to become more important due to both current and proposed secondary sanctions.

In December last year, President Joe Biden signed , which introduced secondary sanctions against foreign financial institutions with ties to Russia’s “military-industrial base”.

The order allows the US to impose secondary sanctions on financial institutions outside US jurisdiction determined to have conducted or facilitated any “significant” transactions for Russia’s defence, technology, construction, aerospace and other key industries.

������ by US law firm Cleary Gottlieb, the targeted transactions and services may include maintaining accounts, transferring funds or providing financial services such as payment processing, trade finance and insurance.

In the WSJ’s article, Sergey Mendeleev, founder of Russia’s Garantex crypto exchange, is quoted as saying that secondary sanctions in other parts of the world have led to increased use of Tether.

“If you are looking for a way to pay Iranians, you can perfectly easily pay them with Tether,” he said at a conference in Moscow this year. “No problem.”

However, Adeyemo’s proposals, first communicated to the Senate Banking Committee in November last year, would attempt to close this loophole.

Adeyemo wants to see new secondary sanctions aimed specifically at foreign digital asset providers.

“Unlike banks, foreign cryptocurrency exchanges and some money services businesses do not have or depend on correspondent accounts for all of their transactions,” he said.

“A new secondary sanctions tool would help Treasury to evolve its targeting capabilities and would account for the technological changes that have rendered highly effective tools in traditional payments contexts less effective against virtual currencies.”

Additionally, Adeyemo wants to see new reforms of the Bank Secrecy Act tailored to virtual asset service providers (VASPs), as well as “extraterritorial” powers to pursue offshore VASPs that “harm national security” and take advantage of the US financial system.

“This will also promote a level playing field for US-based VASPs,” he added.