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Why the Tornado Cash case is disrupting the crypto ecosystem

A cryptocurrency “mixing” service has been blacklisted by US authorities. However, some voices in the sector point to an invasion of user privacy.

The battle between regulators and decentralized finance (DeFi) is heating up in the United States. On August 8, the so-called cryptocurrency “mixing” service Tornado Cash was blacklisted by the Office of Foreign Assets Control (OFAC), a US regulatory body. 40 wallet addresses associated with Tornado Cash, which features USDC stablecoins and ethers, are also listed.

Tornado Cash has been accused of laundering more than $7 billion in cryptocurrency since its inception in 2019, of which more than $455 million was allegedly stolen by the Lazarus hacking group linked to North Korea.

“Despite publicly claiming otherwise, Tornado Cash has repeatedly failed to impose effective controls designed to prevent the laundering of funds by malicious cyber actors and without basic measures to address those risks,” it said. Treasury Undersecretary for Terrorism and Financial Intelligence Brian Nelson, statement.

Launched in 2019, Tornado Cash is a “mixer” (or blender) of smart contracts in DeFi that enables anonymization of transactions. In particular, the user can deposit funds on the smart contract that are “mixed” with other funds. After this shuffling, Tornado Cash generates a private key for the user that allows them to withdraw their funds anonymously.

According to data from the specialist site Defi Llama, the total locked value (TVL) on Tornado Cash is about $362 million, with mostly Ether locked.

Ethereum boss used Tornado Cash

Many voices in the crypto ecosystem reacted to OFAC’s decision. Immediately after the move, Ethereum blockchain chief Vitalik Buterin admitted to using Tornado Cash to make an anonymous donation to Ukraine.

Similarly, Circle, which issues the stablecoin USDC, had to freeze 75,000 USDC of Tornado Cash users. In a Twitter thread, Circle chief Jérémy Allaire clarified that OFAC had “crossed a major threshold in the history of the Internet,” but that his company was required to comply with such a decision under penalty of heavy fines.

“OFAC Exceeded Its Legal Authority”

The latter called on the crypto industry to come together in the coming days “to help advance legal frameworks and policies to protect user privacy and security while developing financial integrity rules to address open source protocols.” For the latter, such a scenario is “a pillar in the fight to protect DeFi and the future of digital currency.”

More specifically, the American association Coin Center, which defends the crypto sector, published an analysis on Monday entitled “what is and what is not an entity subject to sanctions in the case of Tornado Cash?”.

“We believe that OFAC exceeded its statutory authority by blacklisting certain Tornado Cash smart contract addresses, that this action potentially violates constitutional due process and free speech rights, and that OFAC failed to act adequately to mitigate the foreseeable impact that its action would have had on innocent Americans,” Coin Center wrote.

This is not the first time that the United States has sanctioned cryptocurrency “mixers”: in May, the company was also accused of allowing money laundering.

But this case would still differ from the Tornado case for some industry watchers.

“The Tornado Cash entity, which presumably implemented the Tornado Cash app, has no control over the app today. Unlike Blender, it cannot choose whether or not the Tornado Cash app is included in the mix, and it cannot choose which ‘clients’ to take , and which to reject. In the case of Blender, the entity and the application are one and the same. But in the case of Tornado Cash, they are two completely different things. It’s a subtle but important difference that OFAC fails to recognize by treating them as one and the same (as with Blender) and blacklist them as one,” believes Coin. Center.

According to blockchain transaction firm Chainalysis, 18% of the funds that passed through Tornado Cash came from sanctioned entities, and less than 11% were identified as stolen funds.

“As a smart contract based mixer, sanctioning Tornado Cash is not as simple as sanctioning a centralized service like or Hydra Market, because it cannot just stop. A smart contract code can run forever without developer maintenance,” Chainalysis points out in a note.

For the company, while such an OFAC decision is significant, it suggests that decentralized protocols, like centralized platforms, may be subject to regulation.

Furthermore, ua report published in mid-July, Chainalysis noted that “mixing” companies have grown in popularity in 2022 compared to the previous year. If the company recognizes certain “legitimate” reasons for using such a service, it points out the abuses associated with such services.

“Financial privacy is important, especially for people who live under repressive governments or who need to be able to conduct legal transactions anonymously. However, the basic functionality of cryptocurrency mixers, combined with the fact that they rarely, if ever, ask for KYC information (“know your customer “, which corresponds to the customer identification process, editor’s note), making them naturally attractive to cybercriminals,” Chainalysis points out.

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