What happened to Tornado Cash?

Last Monday US Treasury’s Office of Foreign Assets Control (OFAC) sanctioned Tornado Cash for its role in laundering “more than $7 billion” of “proceeds of cybercrimes” since 2019. These cybercrimes included over $455 million stolen in this year’s Ronin bridge hack allegedly performed by North Korean Lazarus Group, hence the OFAC’s intervention.

Tornado Cash is a crypto mixer – a program designed to obfuscate the trace of crypto transactions via a shared pool. However, unlike Blender, a centralized mixer sanctioned in May (without much concern from the crypto industry), it is not an entity, but a decentralized software, running automatically via a set of smart contracts that exist on the Ethereum blockchain.

Notwithstanding that, the OFAC included in its list of sanctioned addresses not only people linked to the mixer, but also the addresses of smart contracts that compose it – and that was the first. 

The ban set off a wave of blockages across crypto platforms.

Circle, the issuer of a centralized stablecoin USDC, has frozen the transfers of over 75k of USDC linked to the sanctioned addresses.

DeFi platforms Aave and dYdX have restricted a number of addresses from accessing their protocols’ web interfaces (smart contracts behind the interfaces stay intact though).

Hosting service for software development Github has removed Tornado Cash’s source code, as well as personal accounts of all its contributors.

 

Unintended consequences

The ban, as well as the first reactions of the companies above, have triggered an industry-wide concern. Some considered distancing themselves from the American companies, while others chose to demonstrate how such ban could hurt innocent users and confuse law enforcement instead of helping it. 

 

Trolling

Blockchain transactions don’t have intermediaries, which means that an incoming crypto transaction cannot be refused. This quality has been exploited by an anonymous user who started trolling celebrities sending them 0.1ETH from Tornado Cash-tainted addresses. Now, according to the Treasury’s logic, TV presenter Jimmy Fallon, comedian Dave Chapelle, Coinbase CEO Brian Armstrong and many others are all suspected of money laundering and law-abiding citizens should not transact with them.

This was clearly a gag, but how would the authorities distinguish a gag from a crime? Almost half of the Ethereum network is just two steps away from the Tornado Cash receiver addresses, and Aave blocking Tron founder Justin Sun because he was airdropped “dirty” ETH shows just how complicated things can get (he got unblocked since).

 

Reducing exposure to American companies

Circle’s freeze of the sanctioned tokens raised many eyebrows in the crypto community, and users started to abandon the stablecoin. Before the ban, USDC was well on route to take over its main competitor Tether. However, unlike Circle, Tether is not an American company, and since the freeze USDC’s market cap lost roughly $1 billion, while Tether’s has gained $1.7 billion.

Users of DeFi protocols relying on USDC are growing wary too. MakerDAO, the governing body of a decentralized stablecoin DAI, which uses USDC as part of its collateral, has been discussing dropping or reducing USDC exposure since last week.

 

Defending freedom of speech and privacy

In 1999, software code was ruled to be “speech”, and thus protected by the First Amendment. 

A renowned American crypto think tank Coincenter pointed out that banning non-proprietary smart contracts (= pieces of code) not only conflicted with the OFAC’s power to only block property, but with the First Amendment itself. It also noted that the “$7 billion” that Treasury called “criminal proceeds” in its press release was actually the total amount of crypto that has passed through the mixer since its deployment. Of this amount only 27% is estimated to be linked to criminal activities (data: Chainalysis), which would mean that over two-thirds of its users could be innocent people seeking privacy. 

Coincenter is now considering legal action against the Treasury, while other think tanks like the DeFi Education Fund prepare to petition the OFAC for a “general license” that would allow all innocent persons affected by the ban withdraw their funds from the mixer without each having to file individually.

In the crypto space AML is more nuanced than in the fiat one, and while banning people’s addresses is common practice, banning smart contracts’ addresses can pose major problems both for companies seeking compliance and users who unwillingly got tainted.

The Tornado Cash ban has raised many questions as to the ways the crypto industry operates, and it is likely to inspire the next cycle of crypto industry’s development, focused on better decentralization and privacy.

Written by D.Center