The battle between the crypto community and the US government over financial privacy has just escalated dramatically, amid government efforts to crack down on criminals.
Tornado Cash is a service that helps some cryptocurrency owners protect their anonymity by blurring the tracks of information on the blockchain. On Monday, the Treasury Department banned Americans from using the service, arguing that it played a central role in laundering more than $7 billion.
In a statement, the Office of Foreign Assets Control (OFAC), an agency of the Treasury Department, called Tornado Cash a “significant threat to the national security” of the United States and alleged that it had been used in several taken over by North Korean hackers to launder money from multi-million dollar thefts.
But the decision has drawn strong reactions from many in the crypto community, who view it as a government override contrary to their core values of privacy and autonomy. On Twitter, crypto lawyer Collins Belton called it’s “arguably the most significant legal action to take place in crypto” and warned that it could produce “absolutely gargantuan ripple effects.”
The Treasury’s decision could end up significantly changing the way users interact with crypto. It also sets the stage for a series of fierce legal and rhetorical battles between the crypto industry and the US government.
hide the crime
When someone sends cryptocurrency from one account to another, a record of the transaction is burned into the blockchain forever. Investigators or eagle-eyed detectives can then use this public information to track the flow of money and learn more about a person’s or company’s financial activity. The US Department of Justice, for example, traced blockchain records to shut down a global child abuse website and arrest hundreds of offenders.
This transparency has given rise to the creation of “mixing” services, intended to mask activity on the blockchain. A user can deposit cryptocurrency into a mixer, which uses complex cryptography to obfuscate the money trail, and then send it to a brand new wallet address. From there, the user can retrieve the funds and optionally cash them out anonymously.
As the use of cryptocurrency has exploded for both legal and illegal activities, mixers have become a “go-to tool for cybercriminals”, according to a recent report by blockchain analytics firm Chainalysis. The study indicates that almost 10% of all funds sent from illicit addresses are sent to mixers, and that the use of mixers in illicit activities has increased significantly in 2022.
“Mixers are a small part of the overall cryptocurrency ecosystem, but play a significant role in illicit activity,” Andrew Fierman, head of sanctions strategy at Chainalysis, wrote to TIME in an email. .
The role of North Korea
A major driver of the rise is increased activity by North Korean hackers, according to US officials. In April, US Treasury officials accused the Lazarus Group, a hacking organization allegedly sponsored by the North Korean government, of spearheading the $600 million hack of Axie Infinity’s Ronin Network, the popular crypto game. These officials accused the North Korean government of using the hack to “generate revenue for its weapons of mass destruction and ballistic missile programs.”
And the Ronin attackers used Tornado Cash to launder the money, officials say. They say that after $600 million drained from the Ronin network to a wallet controlled by the Lazarus Group, it was then sent to intermediate wallets and then flushed through Tornado Cash, $10 million at a time. Attempts by Tornado Cash developers to prevent the Lazarus wallet from interacting with Tornado Cash have failed: around 18% of the total amount of Ether circulating in Tornado Cash over the past few months, or 167,400 ETH, came from the Ronin hack , according to the blockchain analytics firm. Nansen.
Ari Redbord, head of legal and government affairs at crypto regulatory startup TRM Labs, said the Ronin hack was a major turning point in crypto regulation. “Ronin really changed the way the US government views money laundering in the crypto space: they went from thinking hacks were a financial crime to thinking they were a real security issue. national,” he said.
Redbord estimates that $1 billion of North Korea-related laundered funds passed through Tornado Cash, and that the top ten hacks by North Korean hackers used Tornado Cash to launder these funds.
So on Monday, the Treasury Department placed Tornado Cash and associated smart contract wallet addresses on their Specially Designated Nationals (SDN) list, similar to how they would be an enemy of the state. Any Americans who interact with these addresses can now face criminal penalties.
But if Tornado Cash is used by criminals, it is also widely and legally used by all types of users. “There are all sorts of reasons people want to build anonymity: I don’t want anyone looking at my credit card statements or Venmo,” Redbord says.
This week, Tornado Cash proponents argued that the service is simply a neutral tool that can be used for better or for worse: whether it’s akin to virtual private networks (VPNs) or The Onion Router. (TOR).
“It’s roughly the equivalent of sanctioning the email protocol in the early days of the internet, with the rationale that email is often used to facilitate phishing attacks,” said Lia Holland, director of campaigns and communications from the non-profit organization Fight for the Future. , wrote in a statement.
There are many reasons why someone would want to use Tornado Cash: An employee who is paid by their company in crypto, for example, may not want their employer to know all of their financial details. An NFT enthusiast who has recently made a lot of money through savvy investing may not want to become a target for possible harassment or theft.
Tornado Cash can also be useful for those living under oppressive governments. Vitalik Buterin, the founder of Ethereum, came to the defense of the service this week, write on twitter that he himself used Tornado Cash to donate to Ukrainian causes without putting recipient organizations under additional scrutiny. And after the overthrow of Roe v. Wade, donors to abortion funds may want to use Tornado Cash to keep their identities hidden.
The Brewing Battles
The Treasury’s decision to ban Tornado Cash could prove to be a significant turning point for crypto in several ways. First, it shows how far the US government is willing to go in its attempts to corral crypto as it moves towards mainstream adoption. Tornado Cash advocates pointed out that the decision is unprecedented in that sanctions were imposed on a piece of code rather than an entity. (Tornado Cash is not an incorporated organization, but a mechanism controlled by software logic.) This step could mean that other types of decentralized organizations, including other smart contracts or DAOs (decentralized autonomous organizations ), could soon be in the crosshairs.
Redbord of TRM Labs says the Treasury’s decision reveals the US government’s desire to push crypto to more centralized and easier to regulate systems and platforms. The Coinbase trading platform, for example, has requirements that tie every crypto wallet to a verifiable human identity. “This action sends a message to crypto exchanges that they need to ensure they have compliance controls in place to prevent cybercriminals from using their platforms,” Redbord said.
And some major crypto players have fallen online. Circle, the issuer of USD Coin (USDC), the second-largest stablecoin, froze more than $75,000 in funds tied to Tornado Cash addresses. And Github, a Microsoft-owned software development platform, deleted Tornado Cash developer accounts.
But crypto enthusiasts resist centralized attempts to control policies or transactions. Bitcoin, after all, was created in the wake of the financial crash of 2008, with early adopters looking for a global, unregulated form of currency that was resistant to Wall Street pressures. Many have flocked to crypto because it allows anonymous financial transactions, free from the scrutiny of authorities.
In recent days, Tornado Cash defenders have launched their own offensive against the decision, in several ways. First, they drew attention to a perceived logical flaw in the ruling: that anyone who interacts with a Tornado Cash contract is doing so illegally. Individual users cannot reject incoming transactions – small amounts of cryptocurrency have been sent to large public wallet addresses – including those associated with Jimmy Fallon and Shaquille O’Neal— in a stunt that essentially dares the Treasury to take action against an entire community. (Redbord, for what it’s worth, says he doubts individuals were the target of the ruling in the first place, or that OFAC is paying much attention to the campaign.)
A much bigger battle may be underway: some prominent crypto lawyers have started tossing around the idea of challenging the decision on constitutional grounds. “To ban the publication of software is to ban speech,” Peter Van Valkenburgh, director of research at the Coin Center, said Monday at a crypto conference in Las Vegas. “Even laws that unreasonably chill speech are constitutionally suspect and can be challenged before they are even enforced.”
As crypto enthusiasts search for a way forward, they face several tough choices: how much to compromise their values in their quest to reach the mainstream; how to repress illegal activity in systems designed to resist surveillance; and whether to cooperate with governments or oppose them, thus provoking even more anger and scrutiny. For now, it looks like many players in the crypto space are responding forcefully to the Treasury’s decision by taking an ideological stance. “While most people will never use a service like Tornado Cash, the government’s approach sets a dangerous precedent for limiting Americans’ right to use privacy tools for legitimate and legal reasons,” Miller said. Whitehouse-Levine, Policy Director of The DeFi Education. Fund, wrote in an email to TIME. “Privacy is not – and cannot become – a crime.”
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