US prosecutors have become increasingly aggressive in freezing digital assets suspected of being linked to illicit activities such as money laundering, “pig butchery” schemes, sanctions violations and other financial crimes. The freezing of digital assets, however, takes on a new dimension when it is voluntarily initiated by the issuer at the request of the government, bypassing the legal protections of a traditional asset seizure. In such cases, digital asset holders are often caught off guard, unaware that their funds would be tainted and suddenly deprived of access to assets or income acquired through legitimate means.
Traditional asset seizures
In traditional financial crimes investigations, the federal government’s power to withhold or seize assets is governed by established legal and constitutional safeguards. Law enforcement generally must demonstrate a connection between the property and suspected criminal activity and obtain judicial authorization, such as a seizure warrant, before restricting access to such assets.
Seized property is then subject to the federal forfeiture regime, which operates through overlapping authorities, including civil forfeiture under 18 USC §§ 981 and 983, and criminal forfeiture under 18 USC § 982.
Blacklist of digital assets
Voluntary freezes of digital assets represent a break with traditional seizure processes. Rather than obtaining judicial authorization, law enforcement can request an issuer to freeze or blacklist specific wallet addresses. This practice was strengthened by the GENIUS Act, which requires stablecoin issuers to maintain the technical ability to freeze, burn, or otherwise restrict tokens in order to comply with law enforcement guidelines.
For affected digital asset holders, recourse through a stablecoin or other digital asset issuer is often limited, as such issuers typically rely on the requesting government agency and are unaware of the underlying reason for the freeze. As a result, individuals and entities whose assets have been frozen must generally apply directly to the appropriate government authority for relief.
These challenges are compounded by two defining characteristics of blockchain systems: pseudonymity and traceability. Although wallet addresses do not inherently reveal the identity of their owners, blockchain transactions are publicly visible and can be traced across multiple transfers without the use of mixers or other privacy-enhancing services. Law enforcement therefore regularly uses blockchain forensic tools to track the movement of funds from wallets suspected of being involved in illicit activities.
At the same time, tracking funds on a decentralized network introduces significant uncertainty due to wallet pseudonymity. Although investigators can identify an initial source of illicit activity, they are often unable or choose not to devote the resources necessary to distinguish between downstream wallets controlled by individuals involved in the criminal scheme and those controlled by innocent bystanders who unwittingly received the allegedly tainted funds.
In our experience – including successfully unlocking tens of millions of dollars of unjustly frozen funds – it is not enough to report 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 unequivocally shifting the burden of proof from the investigating agency to the digital asset holder whose funds were frozen.
Simply put, the approach of American law enforcement is to freeze first and ask questions later – then demand that the owners of the frozen digital assets 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, ten, or even 20 hops down the line from illicit activity.
Practical advice for stablecoin issuers and those affected by the stablecoin freeze
Despite the challenges involved, participants on both sides of government demands to freeze digital assets – issuers and holders – have various means to protect themselves:
Individuals and entities affected by the freezing of digital assets
When a portfolio is frozen, the window for effective response can be narrow and initial missteps can be difficult to correct. To minimize these risks, we recommend that holders of digital assets:
- Hire attorneys with experience not only in criminal defense and working with government agencies, but also specifically in digital assets, transactions, and digital asset tracing.
- Gather a clear factual record: how the funds were acquired, the purpose of the transactions and any due diligence carried out on the counterparties. For entities, this should also include relevant internal policies governing the use of digital assets. The aim is to present a coherent and well-supported narrative demonstrating that the funds were obtained and used for legitimate purposes, without prior knowledge of any underlying illicit activity.
- Consider a proactive approach. In some cases, it may be beneficial to proactively work with the government agency responsible for the freeze, rather than waiting for additional action. Early engagement, if managed carefully, can help shape the narrative before the government’s speculative assumptions solidify into hardened narratives.
- And of course, be careful. Communications with issuers or investigators may result in legal consequences, and statements made without a full understanding of the facts or legal situation may complicate efforts to obtain the release of funds.
Digital asset issuers
To reduce exposure to civil lawsuits from users who believe their assets have been improperly frozen, digital asset issuers can:
- Adopt clear and consistent procedures when responding to government freeze requests, including how and whether issuers respond to user requests for information.
- Maintain an internal policy governing when and how these requests are honored, particularly when the request is not supported by a court order or other mandatory process.
- Clearly state in the Terms of Service or other documentation that the issuer complies with government freeze requests, including those not accompanied by a court order or other mandatory process, if applicable.
- Maintain a record of all communications with government agencies or users in relation to specific freeze requests and the basis for carrying out the freeze.
