OFAC’s Tornado Cash Sanctions

The sanctions stipulate that any assets within Tornado Cash must be frozen, transactions to and from the mixer are prohibited, and the mixer’s code itself is banned (although it can’t technically be shut down). 

The move was concerning for crypto enthusiasts who feel that OFAC is overstepping its authority by targeting a digital asset with sanctions rather than a person or organization. There is also concern that these sanctions may have future implications for crypto users’ privacy and may lead to future shutdowns. A lawsuit, funded by crypto exchange Coinbase, was brought against the US Treasury Department in response. 

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What Is a Crypto Mixer? 

A cryptocurrency mixer or tumbler mixes different streams of potentially identifiable digital currencies together to improve the anonymity of transactions, making them harder to trace. The owner of the cryptocurrency transfers the money to the mixer, which combines it with the currency of other users and then transfers the mixed currency to the desired address for a small fee. This effectively removes the connection between the address and the original transaction, which makes it a perfect vehicle for money laundering. Transaction amounts can be chosen at random so that every transaction is made up of many small partial payments spread over time. 

Tornado Cash was the first decentralized application on the Ethereum blockchain to offer private transactions and has allegedly mixed millions in stolen funds, including funds from a heist led by the Democratic People’s Republic of Korea, a sanctioned hacking group. Some sources believe that 23% of funds sent to mixers are connected to illicit activity. 

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Sanctions and Crypto

OFAC enforces economic sanctions on countries, individuals and business entities as a deterrent against prohibited activities. The recent sanction against Tornado Cash is a so-called list-based sanction, which calls for the assets in their possession to be blocked, and prohibits transactions with the company or any associated actors. 

There are very specific guidelines for sanctions against virtual currencies. Under the sanction, anyone holding a blocked cryptocurrency must report the asset to OFAC within ten business days of the currency being blocked. They are also required to deny anyone access to the asset, which means it cannot be sold or traded. Special permission to withdraw funds has to be obtained from OFAC. 

In the Tornado Cash instance, US users are no longer allowed (as of August 2022) to send any assets through the mixer or retrieve any funds stuck on the platform without explicit permission from OFAC, although the regulatory body has said they would look favorably on applications from users seeking to withdraw their funds. 

The fall-out of the sanction has been widespread, but whether or not it has been effective remains to be seen. Circle, the issuer of the USDC stablecoin, has frozen more than $75,000 of assets on the platform. Others have not been equally responsive. Tether’s developers have made a public statement that they will not freeze accounts associated with Tornado Cash until they’ve received a direct request from OFAC to do so, while Coinbase has funded a lawsuit against the US Treasury on behalf of six individuals who claim the Treasury has overstepped by blocking the software, instead of individual actors. 

For most crypto users, sanctions at this level won’t have a massive impact on their investments, but it does suggest the possibility that other crypto platforms used for money laundering could be shut down. Decentralized finance apps like mixers are often accused of operating like the “Wild West”, operating without intermediaries or even internal regulations, exposing them to government regulation or penalties. 

Tornado Cash operates on the Ethereum blockchain, which could impact Ethereum. If regulators were to ask validators to block blacklisted Ethereum addresses and the majority complies with the directive, the blockchain would effectively become more regulated. Whether a request like this will be made and whether or not validators will comply remains to be seen.

To keep your crypto investment safe, it’s best to invest in cryptocurrencies from vetted providers that are compliant and knowledgeable about recent regulations. In a decentralized environment of cryptocurrency, it’s important to invest in products with a clean track record. Penalties for a violation of OFAC sanctions can vary in severity, from a warning letter to a significant fine or criminal investigation. 

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Compliance and Crypto Companies 

As a modern crypto platform or DeFi app, it’s not possible to predict whether or not your service will be used for illegal means. Complying with sanctions can be difficult as well - the day after Tornado Cash was sanctioned, anonymous users sent small transactions from the mixer to high-profile Ethereum accounts, which were not able to block the transfer. This process, known as dusting, is commonplace, and recipients should file a report with OFAC within ten business days if this occurs. 

Clearly, the Tornado Cash sanctions should serve as a warning as it has set a standard for future government crackdowns on crypto. As all of its addresses were seized, and assets were frozen, this could have devastating consequences. 

DeFi apps and crypto platforms should create instruments to identify and deal with money laundering at the onboarding level and during the normal course of operations. Taking preventative measures to avoid illicit activity from occurring on their platforms may be the best defense against a potential future shutdown that could affect not only your company but your legitimate customers. 

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