This article was originally written by ChainDD by Dorji
On November 27, the U.S. Court of Appeals for the Fifth Circuit overturned the sanctions imposed by the Office of Foreign Assets Control (OFAC) on Tornado Cash smart contracts, finding that the sanctions exceeded the scope of its administrative authority. The court held that while the Treasury Department had the authority to take action against "property," Tornado Cash's immutable smart contracts could not be owned and controlled, and therefore did not meet the definition of property. The inclusion of it on the "Specially Designated Nationals and Blocked Persons List" (SDN List) was considered to be beyond the scope of legal authorization.
This verdict marks the end of the more than two-year-long legal battle in the coin mixer Tornado Cash case, and it is a huge victory for the crypto world. The hard-hit crypto privacy track will be revitalized. It also means that under the existing legal framework, decentralized smart contracts will not be recognized as property and cannot be sanctioned under current laws, laying a solid legal foundation for their future development.
It is worth noting that behind this Tornado Cash case is not only the struggle for survival of the crypto privacy track represented by Tornado Cash, but also the strong support of Coinbase, which represents the power of American cryptography. Not only do two of the plaintiffs have Coinbase backgrounds, but they also provide legal assistance. Coinbase Chief Legal Officer Paul Grewal publicly stated that this is a historic victory for cryptocurrencies and all those who care about defending freedom. Now, these smart contracts must be removed from the sanctions list, and American users will once again be allowed to use this privacy-protecting protocol. Excessive government intervention will not stand firm.
Ripple’s Chief Legal Officer Stuart Alderoty also said in First Through X: “This week, a federal court rejected the U.S. SEC dealer rules and ruled that the Treasury Department’s sanctions on Tornado Cash smart contracts were illegal. These two things have a common theme: regulators do not make laws, they just enforce the text of the law. If they want more power, only Congress can grant it.”
Tornado Cash is not an asset: a privacy track or a money laundering tool?
OFAC sanctions on Tornado Cash date back to 2022, when 38 Ethereum smart contracts related to Tornado Cash and 38 Ethereum smart contract addresses related to the Tornado Cash application were added to the U.S. Specially Designated Nationals (SDN) list, making it a restricted entity. This is the first time that the U.S. government has imposed sanctions on smart contract applications.
After the United States imposed sanctions, Germany, France, South Korea and other countries investigated, warned and sanctioned Tornado. Ethereum node suppliers, wallets and code bases quickly banned Tornado Cash users from accessing it. What was once the world's largest coin mixer quickly collapsed. Although Tornado Cash is still available, the number of Tornado Cash users has dropped dramatically due to the ban on the web front end and the closure of third-party interactions.
Why is Tornado Cash targeted by the US government? Why is it a favorite application of criminals?
Tornado.Cash is a fully decentralized, non-custodial protocol that improves transaction privacy by breaking the on-chain link between source and destination addresses. To protect privacy, Tornado.Cash uses a smart contract that accepts deposits of ETH and other tokens from one address and allows them to be withdrawn to different addresses, that is, ETH and other tokens can be sent to any address in a way that hides the sending address. These smart contracts act as a pool that mixes all deposited assets. When you put funds into the pool (ie, deposit), a private credential (random key) is generated to prove that you have performed the deposit operation. This private credential then serves as your private key when withdrawing. The contract transfers ETH or other tokens to the specified receiving address. The same user can use different withdrawal addresses.
Through the form of a coin mixer, there is no way to effectively trace the source of the funds received. This is not only an excellent breakthrough in protecting privacy, but also allows the marked black money and robber addresses to be laundered, becoming a money laundering tool in the eyes of hackers.
Since its launch in August 2019, until it was sanctioned by the United States, Tornado Cash was the most popular mixer in the entire Crypto ecosystem, with a cumulative TVL of $7.6 billion. At the same time, more than 90% of its funds are stored on Ethereum and run through smart contracts on Ethereum. It is also the largest privacy application on Ethereum.
OFAC, which is affiliated with the U.S. Treasury Department and has always been concerned about cryptocurrencies, has previously imposed sanctions on individuals and entities related to cryptocurrencies and addresses related to them. The sanctions on Tornado Cash this time are due to money laundering and criminal transactions.
As the largest privacy coin, Tornado’s mixer not only effectively protects user privacy, but also provides a breeding ground for criminal activities. According to data provided by OFAC, Tornado Cash has been used to launder more than $7 billion in virtual currencies since its launch, of which about 35% of the transaction volume comes from criminal organizations.
The direct trigger for Tornado Cash to be sanctioned by OFAC was that the North Korean hacker group Lazarus Group laundered nearly $1 billion in stolen cryptocurrencies through coin mixers. OFAC accused Tornado Cash of being the main money laundering tool of Lazarus Group.
OFAC stated that the sanctions on Tornado Cash were because it assisted, sponsored, or provided financial, material or technical support, or provided goods or services for most cyber activities originating from outside the United States, which could pose a significant threat to the national security, foreign policy, economic health or financial stability of the United States, and lead to the serious theft of funds or economic resources, trade secrets, personal identification or financial information, allowing certain criminals to gain commercial or competitive advantages or private economic benefits.
Through the sanctions on Tornado Cash, the coin mixer ecosystem has suffered an unprecedented blow. For legal security reasons, various ecosystems have questioned the coin mixer ecosystem. From an objective point of view, money laundering has indeed been effectively combated, but for the crypto ecosystem, there are question marks about the privacy track and the prospects of decentralized applications. Even for the stablecoin ecosystem and the DeFi ecosystem, it is not positive news. If the stablecoin is pledged through stablecoins and is frozen, there will be problems with the identification of assets and liabilities.
This is also the reason why Coinbase has been actively promoting the case. Fortunately, the final result is good for the crypto community.
After the court ruling was announced, Tornado Cash protocol token TORN rose rapidly, rising from a low of $3.7 to a high of $35.74 within an hour. As of press time, TORN is currently stable at around $14.
The surge in prices shows the flow of whale funds and the direction of the market, and is full of confidence in the future of Tornado Cash and its protocol token TORN.
The victory of smart contracts: the legal boundaries have been drawn
In any case, the victory of this judgment is a very significant event for the crypto industry. It is not only about the legality of the privacy tools behind Tornado Cash, but more importantly, it has drawn clear legal boundaries for the development of the entire blockchain industry and decentralized technology. The particularity of immutable smart contracts has also received attention, and in the future, the legal use of similar technologies has important judicial support. The US legal system recognizes decentralized protocols as a new type of infrastructure.
Haun Ventures, a venture capital firm owned by Katie Haun, a former a16z executive, has previously pointed out that OFAC's blocking of open source and self-executing software is an overreach at the legal level. These software are neither the "property" of any foreign individual or entity nor belong to anyone. No matter how noble OFAC's intentions are, it is not given such broad authority to crack down on open source software architecture. OFAC should focus its sanctions on malicious actors who abuse open source software, not the tools themselves.
For Tornado Cash, the interaction data has been falling sharply after being sanctioned, but Tornado Cash is still one of the more popular privacy platforms in the encryption field. Tornado Cash's deposit volume has shown a significant recovery since the beginning of this year. It received US$1.9 billion in deposits in the first half of this year alone, a significant increase of about 50% compared with the total deposit amount in 2023.
It should be noted that for privacy projects such as Tornado Cash, the challenges are far from over. Due to the limitations of third-party interfaces, the general interaction data of its platform has dropped significantly, so the money laundering charges it faces still exist. This judgment can be seen as a victory for smart contracts. From now on, smart contracts that are not controlled by Huan will no longer be regarded as asset management, but it is not a victory for the privacy track. Although the privacy track has taken a big step forward, there are still many challenges waiting for the future with regulatory authorities.
For regulators, in addition to sanctioning smart contracts, how to curb illegal uses on the edge of technological innovation and privacy protection is a difficult problem they need to face.
Finally, the direct beneficiaries of this ruling are the Ethereum ecosystem and the DeFi ecosystem. 10X Research stated in a report to investors after the ruling was announced: Although this ruling does not recognize money laundering, it sets a precedent that allows programmers to develop and release smart contract protocols without charging fees and without worrying about sanctions. Since Ethereum is still the main battlefield of DeFi, this decision has positive implications for the broader DeFi ecosystem and other protocols (especially on the Ethereum network).
(This article was first published on Liande APP)
