US prosecutors have become increasingly aggressive in freezing digital assets believed to be traceable to illegal activities such as money laundering, “pig slaughter”, sanctions violations and other financial crimes. Freezing digital assets takes on a new dimension, however, when the freeze is voluntarily initiated by the issuer at the request of the government, bypassing the legal protections of a traditional asset seizure. In such cases, holders of digital assets are often caught off guard, unaware that their funds are allegedly tainted, and suddenly deprived of access to assets or income acquired through legitimate means.
Traditional asset seizures
In traditional economic crime investigations, the federal government’s authority to detain or seize assets is governed by established legal and constitutional safeguards. Law enforcement typically must demonstrate a connection between the property and alleged criminal activity and obtain a judicial authorization, such as a seizure warrant, before restricting access to those assets.
Seized assets are 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.
Blacklisting of digital assets
Voluntary freezes on digital assets represent a departure from traditional seizure processes. Instead of obtaining a legal authorization, law enforcement authorities may request that an issuer freeze or blacklist specific wallet addresses. This practice has been reinforced by the GENIUS Act, which requires stablecoin issuers to maintain the technical capacity to freeze, burn, or otherwise restrict tokens to comply with law enforcement directives.
For affected digital asset holders, recourse through stablecoin or other digital asset issuers is often limited because these issuers generally approach the requesting government agency and do not know the underlying basis for the freeze. As a result, individuals and entities whose assets have been frozen typically must engage directly with the appropriate governmental authority to seek relief.
These challenges are compounded by two defining features 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 tracked across multiple transfers without the use of mixers or other privacy-enhancing services. Thus, law enforcement agencies routinely use blockchain forensic tools to track the movement of funds originating from wallets suspected of involvement in illegal activity.
At the same time, tracking funds across a decentralized network introduces significant uncertainty due to pseudonymity in the wallet. Even if investigators can identify an initial source of illegal activity, they are often unable or choose not to use the resources required to distinguish between downstream wallets controlled by individuals involved in the criminal scheme and those controlled by innocent bystanders who have unwittingly received the allegedly tainted funds.
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 illegal activity and the downstream frozen wallet. Government authorities 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 investigative agency to the digital asset holder whose funds have been frozen.
In short, the approach of American law enforcement is to freeze first, ask questions later – and then requiring owners of the frozen digital assets to prove their innocence in order to recover their funds. This tactic, combined with US law enforcement’s expansive view of US 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 illegal activity.
Practical tips for stablecoin issuers and those affected by stablecoin freezes
Despite the challenges involved, participants on both sides of government requests to freeze digital assets – both issuers and holders – maintain a variety of ways to protect themselves:
Individuals and entities affected by the freezing of digital assets
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 holders of digital assets:
- Engage counsel with experience not only in criminal defense and cooperation with government authorities, but also specifically in digital asset matters, digital asset transactions and tracing.
- Gather 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 for the use of digital assets. The goal is to present a coherent and well-substantiated account showing that the funds were obtained and used for legitimate purposes without knowledge of any underlying upstream illegal activity.
- Consider a proactive approach. In some cases, it may be beneficial to proactively engage with the public authority responsible for the freeze rather than waiting for further action. Early engagement, if handled carefully, can help shape the narrative before the government’s speculative assumptions solidify into hardened narratives.
- And of course you have to be careful. Communications with issuers or investigators may have legal implications, and statements made without a full understanding of the facts or legal position may complicate efforts to secure the release of funds.
Issuers of digital assets
To reduce exposure to civil lawsuits from users who believe their assets have been wrongfully frozen, issuers of digital assets can:
- Adopt clear, consistent procedures when responding to government freeze requests, including how and whether issuers respond to user requests for information.
- Maintain an internal policy on when and how such requests are complied with, particularly where the request is not supported by a court order or other mandatory process.
- Make clear in the terms of use or other documentation that the issuer complies with freeze requests from authorities, including those not accompanied by a court order or other mandatory process, if applicable.
- Maintain a record of all communications with government authorities or users regarding specific freeze requests and the basis for implementing the freeze.
