Update: August 1st - 14th, 2022
The US Treasury Department sanctioned Tornado Cash, a crypto mixing service, placing an unprecedented ban on a smart contract...
Welcome back,
A very interesting debate came to light in recent news, and this topic has dominated industry discussions around policy, government, and the future of crypto. Because of how interesting this discussion is, I decided to focus the entire newsletter on this topic (other headlines will, of course, be included at the very end).
I hope you enjoy and see you soon.
-Katja
August 1st - 14th, 2022
The US Treasury Department sanctioned Tornado Cash, a crypto mixing service, placing an unprecedented ban on a smart contract.
The Treasury added Tornado Cash to the Office of Foreign Assets Control (OFAC) Specially Designated Nationals (SDN) list, a tool to identify and block the assets of threats to the national security, foreign policy or economy of the United States. Americans are banned from interacting with individuals and entities on the SDN list.
The Department put out the following statement detailing the reasons [allegations] behind these recent sanctions,
“Today, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) sanctioned virtual currency mixer Tornado Cash, which has been used to launder more than $7 billion worth of virtual currency since its creation in 2019. This includes over $455 million stolen by the Lazarus Group, a Democratic People’s Republic of Korea (DPRK) state-sponsored hacking group that was sanctioned by the U.S. in 2019, in the largest known virtual currency heist to date. Tornado Cash was subsequently used to launder more than $96 million of malicious cyber actors’ funds derived from the June 24, 2022 Harmony Bridge Heist, and at least $7.8 million from the August 2, 2022 Nomad Heist. Today’s action is being taken pursuant to Executive Order (E.O.) 13694, as amended, and follows OFAC’s May 6, 2022 designation of virtual currency mixer Blender.io (Blender).”
[See this article for more information on money laundering and Tornado Cash.]
What’s not surprising is the government going after illicit activity. What is surprising is how the government is going about dealing with this illicit activity. Tornado Cash is a crypto mixing service that scrambles transaction information before putting it on the blockchain in an effort to increase anonymity. To reiterate - Tornado Cash is not a person or entity; it’s a private transaction protocol. Not only is Tornado Cash just code, but it is open-sourced and decentralized (governed by a DAO).
Within this context, these sanctions could be equivalent to the US government levying a ban on email because of phishing attacks. In addition to this, concerns around free speech and privacy have also surfaced.
From the government side, Brian Nelson, Treasury’s undersecretary for terrorism and financial intelligence, explained,
“Despite public assurances otherwise, Tornado Cash has repeatedly failed to impose effective controls designed to stop it from laundering funds for malicious cyber actors on a regular basis and without basic measures to address its risks”
A report by Chainalysis, a major blockchain data platform, emphasized this point,
“The data shows that mixers pose a significant money laundering risk. 25% of mixed funds come from illicit addresses, and cybercriminals associated with hostile governments are among those taking the most advantage.”
From the industry side, Coin Center, a crypto policy think tank, raised Constitutional concerns related to the sanctions,
“Today’s action does not seem so much a sanction against a person or entity with agency. It appears, instead, to be the sanctioning of a tool that is neutral in character and that can be put to good or bad uses like any other technology. It is not any specific bad actor who is being sanctioned, but instead it is all Americans who may wish to use this automated tool in order to protect their own privacy while transacting online who are having their liberty curtailed without the benefit of any due process …
Even worse, because of the nature of blockchain transactions, an American who is sent money through the Tornado.cash address is not even able to reject the transaction, and yet may be, at that moment, technically in violation of OFAC rules.”
[I recommend reading the Coin Center’s statement (previous link) for more on this perspective.]
Despite the prohibition of this protocol, the government cannot shut the application down or prevent it from redeploying on a non-sanctioned address. This is why the US Treasury Department has put itself in a difficult situation: instead of targeting nefarious players, it’s targeting the tools they use.
I expect this debate between the government and the industry to continue in the weeks and months to come. In the meanwhile, actions against Tornado Cash will escalate. Already, GitHub accounts of the Tornado Cash team appeared to be suspended, Circle froze the USDC funds in Tornado Cash's sanctioned wallets, and a Tornado Cash developer was arrested by Dutch authorities.
In other US news …
Senators introduce a bill to put crypto under CFTC’s watch. In related news, some Senators are reintroducing an amendment to clarify the 'broker' provision after the passage of the infrastructure bill last year.
Senator Warren (D-MA) is circulating a letter around the Senate to urge the Office of the Comptroller of the Currency to withdraw legal guidance that has allowed banks to venture into the crypto space.
The CFTC and SEC have voted to propose a joint rule to require hedge funds to report their crypto exposure “to bring transparency to risk previously hidden.”
More news …
The Philippines will stop accepting new Virtual Asset Service Provider (VASP) license applications for three years “to strike a balance between promoting innovation in the financial sector and ensuring that associated risks remain within manageable levels.”
Governments continue to battle it out with crypto exchanges - Portuguese banks started shutting down the accounts of crypto exchanges citing “risk management” concerns. Uzbekistan blocks access to foreign crypto exchanges over allegations of unlicensed activity.The Directorate of Enforcement of India froze tens of millions in two crypto exchanges over money laundering allegations (the same agency is conducting more investigations into other companies).
Not everything is negative in crypto exchanges news, as Binance (one of the major crypto exchanges) partnered with Mastercard to launch prepaid crypto cards for Argentinian residents.
Central banks around the world are continuing their journey into digital currencies and CBDCs with Russia and Thailand set to pilot their projects within the next two years. [In related news, the European Central Bank recognized CBDCs as the best cross-border payment medium.]