From prohibition to enthusiasm, the attitude of the fighting nation towards Bitcoin and blockchain has changed dramatically

Editor's note: Brian Zimbler is an attorney and senior partner in the Moscow office of Morgan Lewis, an international law firm. He has unique insights into cross-border investment and finance, especially in emerging markets.

In the article, co-authored by Zimbler and his colleagues Dmitry Dmitriev and Andrey Ignatenko, the authors investigate the evolution of the Russian authorities’ attitude towards blockchain and Bitcoin.

Blockchain technology has attracted the interest of major Russian financial institutions and IT companies, and has the potential to allay the skepticism of Russian regulators. This is perhaps not surprising, given Russia's prominence in the tech sector, with more than 120,000 programmers in the country and continued growth in e-commerce and online activity.

Initially, Bitcoin was banned in Russia

Russian authorities have been looking at the potential uses of cryptocurrencies for several years, with a recent focus on anti-corruption, anti-money laundering measures, legal compliance, and risk management. The Central Bank of Russia and the Ministry of Finance have played a leading role in considering these issues.

Under current Russian law, the ruble is the only national currency in Russia, while other currencies and "currency substitutes" are prohibited. Some Russian officials believe that cryptocurrencies should be considered alternative currencies, but this remains controversial.

In 2014, the Russian Central Bank pointed out in an official notice that the use of virtual currencies to trade goods or services, as well as the conversion of such currencies into rubles or foreign currencies, could be used for money laundering or terrorist financing purposes. Although this warning has no legal effect, it has also served as a warning to major Russian banks and companies.

Softening of stance

In early 2016, Russian authorities seemed ready to further resist cryptocurrencies. It is understood that the Russian Ministry of Finance was preparing to draft amendments to existing laws to impose fines and criminal penalties on the issuance, purchase or sale of Bitcoin. It is reported that institutional fines will be up to 2.5 million rubles (about $39,000), and individuals will be sentenced to up to seven years in prison.

Some other Russian government agencies expressed support for the recommendations, including Russia's Ministry of Economic Development and the Investigative Committee, the federal body for criminal investigations.

However, the Russian government seems to have decided not to stick with these amendments for several main reasons. First, some key departments, such as the Ministry of Justice and the Federal Prosecutor's Office, reportedly do not support the proposed imposition of criminal liability (imprisonment). Some observers believe that Russia's existing laws are sufficient to deal with criminal activities and there is no need to create separate laws for the use of cryptocurrencies.

Secondly, Russian authorities are exploring the potential advantages of Bitcoin and other cryptocurrency-related technologies. As a result, some Russian government departments are developing new legal reforms to provide a legal basis for the use and development of cryptocurrencies.

Supporters include Herman Gref, chairman of Russian banking giant Sberbank. Gref believes that if Russia attempts to ban cryptocurrencies, the country will fall far behind in innovating in blockchain or similar technologies. In addition, other Russian government officials have also expressed interest in blockchain technology.

Testing blockchain

For example, in the fall of 2015, the Central Bank of Russia established a working group to study blockchain technology and explore its potential practical applications (with a focus on financial markets).

In 2016, a consortium consisting of the Central Bank of Russia, Russian payment company QIWI, Accenture, and four Russian financial institutions began collaborating to test blockchain technology. The consortium created a blockchain prototype called Masterchain.

Masterchain is based on Ethereum technology, but it is a private version in which the central bank acts as both a payment processor for ordinary users and a trusted administrator.

The next step for the alliance may be to further develop the prototype. Currently, Russian central bank officials are working on two other versions of Masterchain. Both are based on Ethereum, but the first uses the Proof of Work (POW) consensus algorithm (after Ethereum switches to the POS phase, the prototype will switch to the Proof of Stake (POS) consensus algorithm). The second one is already using the POS consensus algorithm.

It is reported that 10 Russian financial institutions will test these products with the ultimate goal of applying them for commercial use.

Under one proposal, representatives from various government agencies would set up a professional association to help draft laws to regulate blockchain technology.

The new body will oversee various applications of blockchain technology, such as electronic voting, notarization, shareholder maintenance, real estate and other legal registries, and verification of customer profiles and transaction information.

Other Russian organizations and business leaders have also become active in the blockchain space. For example, Russia’s Central Government Registry has launched a blockchain voting pilot project.

Perm State National Research University has set up a laboratory to study "cryptoeconomics" and blockchain systems. In addition, a well-known Russian entrepreneur has invested in the BlockGeeks social media platform, and Russian payment company Qiwi has announced plans to upgrade its core database to a distributed ledger system within five years.

Gray Area

However, in some places, Russia is still a traditional market where physical documents, seals and stamps are essential. In particular, the transition to distributed ledger systems and virtual contracts conflicts with the centralized registries required for some existing exchanges.

In theory, blockchain solutions could address these issues, such as replacing notarial certification and the use of central registries.

However, full adoption of blockchain solutions will require further Russian legal reforms. For example, it is unclear how regulatory issues regarding decentralized autonomous organizations (DAOs) or similar blockchain applications, which have no precedent in Russia, will be addressed.

These issues require further attention from Russian officials, developers, lawyers, and other market participants. Ultimately, if Russia decides to play an active role in the development of blockchain technology, necessary legal changes may need to follow.