Rune Christensen details how MakerDAO handles Tornado cash penalties


JThe decentralized finance (DeFi) ecosystem should prepare for a more adversarial relationship with regulators, warned Rune Christensen, founder of MakerDAO, the decentralized autonomous organization behind stablecoin DAI.

Christensen told CoinDesk TV on Thursday that the U.S. Treasury Department’s sanction coin mixer Tornado Cash could usher in “a new era for DeFi.” On Monday, the agency designated this Tornado Cash, an essential part of the Ethereum ecosystem, as a “national security risk”. The announcement almost immediately cast a large shadow over the crypto industry.

The Treasury decision “opened the door to the possibility of any protocol getting a sanction,” Christensen said on CoinDesk TV’s “First Mover” show. Because Tornado was at the center of so much economic activity on the Ethereum blockchain, DeFi applications must now examine their exposure to Tornado and potentially change course.

“Decentralization has been more of a meme than a reality for many projects,” Christensen said.

This week, members of the MakerDAO community began preparing a “contingency plan” in case its “core” wallets were affected by the sanction. Of particular concern is the large amount of USDC, a stablecoin issued by the regulatory-compliant Center Consortium. Maker holds USDC as collateral on DAI, its US dollar-denominated cryptocurrency.

Circle, one of the entities behind the USDC, immediately blacklisted 38 Ethereum addresses to comply with the Treasury sanction, while a host of so-called permissionless apps like dYdX, Aave and others started freezing user funds if there is even a marginal connection to Tornado.

This increases the pressure on Maker, Christensen said. Maker allows anyone to mint DAI by lending cryptocurrencies to the app. Over a third of DAI is backed by USDC, while around a quarter of its reserves are in ether (ETH). If that ETH or USDC is found to have interacted with Tornado, it could be frozen, leaving Maker with a shortfall.

Christensen said regulated stablecoins like USDC have “proliferated” in DeFi because they are very safe, liquid, and easy to integrate. But there is a natural “tension” between “centralized” stablecoins and projects like DAI that want to be permissionless and uncensored.

The decision to rely on USDC allowed Maker to grow and focus on a simple user experience, but it came with “tradeoffs” that are now fully visible, Christensen said.

Sanction smart contracts

This is not the first time that regulators have blocked access to a crypto mixing service. However, they usually targeted specific individuals or entities behind specific app or users.

Christensen said the decision to sanction a smart contract was “unhelpful and pointless” as it will be impossible for the government to enforce its ban.

“We now know that it is possible to simply sanction an Ethereum address,” he said. While it is doubtful whether the government is targeting specific DeFi applications or stablecoin issuers like Maker, it is concerned about “second-order” effects.

“We don’t really know if we can really count on close collaboration with governments in the long term, which has been the strategy of big DeFi projects like Maker so far,” he said.

In an effort to tether DeFi to the broader traditional economy, MakerDAO has worked to incorporate what it calls “real-world assets.” This includes getting into the mortgage business and potentially allowing people to collateralize non-crypto assets.

Christensen said the penalty put a “wrench in the works” of some of those efforts, as Maker’s U.S. legal partners became concerned about potential new criminal liability.

“They don’t want to be caught up in applying the sanctions,” he said, without naming those partners. “They’re slowing down transactions” and doubling down on compliance and know-your-customer (KYC) regulations.

Down the pike

Christensen said a more aggressive regulatory regime could push DeFi to decentralize further. While the first “era” of DeFi was about building and deploying quickly, the next will be about building redundancy and robustness.

“Stablecoins can choose to be more decentralized and the market will accept that to counter the cost of stability around that,” he said.

As something of an extreme security measure, Christensen floated the idea of depegging US dollar DAI. He said Maker could even arrange for the vast majority (over 75%) of its cash to be held in ETH, which after the merger could be a “very attractive” and quite stable asset that pays out. dividends.

“The ultimate consequence would be that it is simply not possible to have a decentralized stablecoin pegged to the US dollar,” he said. On the other hand, it could mean that stablecoins that are pegged to the dollar are “much more regulated.”

Ultimately, it’s up to the DAO to decide how to proceed. He noted that some members of the community are increasingly skeptical of plans to integrate “real-world assets”.

But even in this new era, the crypto industry has a responsibility to “convince” politicians and investors that crypto is a valuable asset, or “a force for good.” One way to show that “crypto can actually benefit the economy,” Christensen said, would be to act on climate concerns or enter the real estate market.

However, the worst-case scenario, or the “final boss bottle,” as he put it, hinges on the possibility of governments around the world coming together to implement sweeping regulation that “shuts down crypto forever.”

“They won’t be successful, but the degree of success will depend on how prepared DeFi and crypto are for it,” he said.

Read more: What happens when you try to sanction a protocol like Tornado Cash

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