A US court ruled that OFAC's sanctions on Tornado Cash smart contracts exceeded its authority, and the crypto world won a huge victory. The hard-hit crypto privacy track will be revitalized. 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 its future development.
On November 27, the US 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 its administrative authority. The court held that although 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 ruling marks the end of the Tornado Cash case, a coin mixer that has been in legal battle for more than two years, and the crypto world has won a huge victory. 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 its 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 encryption. Not only are two of the plaintiffs with 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.
And Ripple's Chief Legal Officer Stuart Alderoty also said on First Pass 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 letter of the law. If they want more power, only Congress can grant it."
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Tornado Cash is not an asset: a privacy track or a money laundering tool?
OFAC sanctions Tornado Cash date back to 2022, when it added 38 Ethereum smart contracts related to Tornado Cash and 38 Ethereum smart contract addresses related to Tornado Cash applications to the U.S. Specially Designated Nationals (SDN) list, making it a restricted entity. This is the first time the U.S. government has sanctioned smart contract applications.
After the U.S. imposed sanctions, Germany, France, South Korea and other countries investigated, warned and sanctioned Tornado. Ethereum node suppliers, wallets and code libraries quickly banned Tornado Cash users from accessing it. The world's largest coin mixer quickly collapsed. Although Tornado Cash is still available, the number of Tornado Cash users has dropped sharply due to the ban on the web front end and the closure of third-party interactions.
Why is Tornado Cash targeted by the U.S. government? Why is it a favorite application for criminals?
Tornado.Cash is a fully decentralized non-custodial protocol that improves transaction privacy by breaking the on-chain link between the source address and the destination address. To protect privacy, Tornado.Cash uses a smart contract that accepts deposits of ETH and other tokens from one address and allows them to withdraw to different addresses, that is, to send ETH and other tokens 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 (i.e., deposit), a private credential (random key) is generated to prove that you have performed a deposit operation. This private credential then serves as your private key when withdrawing funds, and 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 mixer, there is no way to effectively trace the source of the collected funds, which not only becomes an excellent breakthrough in protecting privacy, but also allows the marked black money and robber addresses to be whitened, 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 has always been concerned about cryptocurrencies, is affiliated with the U.S. Treasury Department. It has previously sanctioned 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 can not only effectively protect user privacy, but also provide a breeding ground for criminal behavior. 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 the mixer, and 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 to most cyber activities 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, resulting in the serious theft of funds or economic resources, trade secrets, personal identification or financial information, and was a way for some criminals to obtain commercial or competitive advantages or private economic benefits.
Through the sanctions on Tornado Cash, the mixer ecosystem has suffered an unprecedented blow, and each ecosystem has questioned the mixer ecosystem for legal security considerations. From an objective point of view, it has indeed effectively cracked down on money laundering, but for the crypto ecosystem, there is a question mark about the privacy track and the prospects of decentralized applications. Even for the stablecoin ecosystem and DeFi ecosystem, it is not a positive news. If the stablecoin is frozen through staking, there will be problems with the identification of assets and liabilities. This is also the driving force behind Coinbase's active promotion of the case. Fortunately, the final result is good for the crypto circle. After the court ruling was announced, the Tornado Cash protocol token TORN rose rapidly, 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 soaring price 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.
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Victory of smart contracts: the legal boundary line has been set
Anyway, the victory of this judgment is a very significant and important 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.
Former a16z executive KatieHaun's venture capital firm Haun Ventures 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 has not been given such broad powers to crack down on open source software architecture. OFAC should focus sanctions on malicious actors who abuse open source software, not the tools themselves.
For Tornado Cash, the interactive data has been falling off a cliff since being sanctioned, but Tornado Cash is still one of the more popular privacy platforms in the encryption field. Tornado Cash has seen a significant recovery in deposits since the beginning of this year, receiving $1.9 billion in deposits in the first half of this year alone, a significant increase of about 50% from the total deposits for the whole year of 2023.
It should be noted that for privacy projects such as Tornado Cash, the challenges are far from over. Due to the limitation of third-party interfaces, the ordinary interaction data of its platform has now 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 control, 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 regulators in the future. 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 that needs to be faced. 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 announcement of the ruling: Although this ruling does not recognize money laundering, it sets a precedent that allows programmers to develop and publish smart contract protocols without charging fees without worrying about sanctions. Since Ethereum is still the main battlefield of DeFi, this decision has positive significance for the broader DeFi ecosystem and other protocols (especially on the Ethereum network).
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