The legal risks and practical considerations of digital asset blacklisting

In our experience – including the successful unlocking of tens of millions of dollars in wrongfully frozen funds – it is not enough to point to the number of transactions, or “hops,” between the upstream illicit activity and the downstream frozen wallet. Government agencies will instead seek to understand how and why the funds were acquired and demand contemporaneous documentary evidence of the legitimacy of the transactions – unfairly but unmistakably shifting the burden of proof from the investigating agency to the digital asset holder whose funds have been frozen.

Simply put, U.S. law enforcement’s approach is to freeze first, and ask questions later – and then to require owners of the frozen digital assets to prove their innocence to get their funds back. This tactic, combined with U.S. law enforcement’s expansive view of U.S. jurisdiction, puts all holders of stablecoins or other digital assets anywhere in the world at risk, whether they unwittingly acquired the assets five, 10, or even 20 hops downstream from illicit activity.

Practical tips for stablecoin issuers and those affected by stablecoin freezes

Notwithstanding the challenges involved, participants on both sides of governmental digital asset freeze requests – both issuers and holders – retain a variety of ways to protect themselves:

Individuals and entities affected by digital asset freezes

When a wallet is frozen, the window to respond effectively can be narrow, and early missteps can be difficult to unwind. To minimize these risks, we recommend digital asset holders:

• Engage counsel with experience not only in criminal defense and engaging with governmental agencies, but also specifically in digital asset matters, digital asset transactions and tracing.
• Assemble a clear factual record: how the funds were acquired, the purpose of the transactions, and any due diligence performed on counterparties. For entities, this should also include relevant internal policies governing digital asset use. The objective is to present a coherent and well-supported account demonstrating that the funds were obtained and used for legitimate purposes, without knowledge of any underlying upstream illicit activity.
• Consider a proactive approach. In some cases, it may be advantageous to engage proactively with the government agency responsible for the freeze, rather than waiting for further action. Early engagement, if carefully handled, can help shape the narrative before the government’s speculative assumptions solidify into hardened narratives.
• And of course, exercise caution. Communications with issuers or investigators may carry legal consequences, and statements made without a full understanding of the facts or legal posture can complicate efforts to secure the release of funds.

Digital asset issuers

To reduce exposure to civil litigation by users who believe their assets have been improperly frozen, digital asset issuers can:

• Adopt clear, consistent procedures when responding to governmental freeze requests, including how and whether issuers respond to user requests for information.
• Maintain an internal policy governing when and how such requests are honored, particularly where the request is not supported by a court order or other compulsory process.
• Make clear in the user terms of service or other documentation that the issuer complies with governmental freeze requests, including those that are not accompanied by a court order or other compulsory process if applicable.
• Maintain a record of all communications with governmental agencies or users in connection with specific freeze requests, and the basis for effecting the freeze.