OFAC Sanctions Virtual Currency Mixing Protocol Connected to Money Laundering Activities
Commentary by Jason Schwartz
OFAC sanctioned a virtual currency mixer responsible for laundering over $7 billion since its inception, as well as facilitating illicit activities for OFAC-sanctioned entities. This is the first time OFAC sanctioned a decentralized technology protocol instead of an individual, group or entity.
The virtual currency mixer was linked to several different criminal organizations and illicit activities, including (i) a heist carried out by a Democratic People's Republic of Korea state-sponsored cyber hacking group that stole $455 million and (ii) the laundering of a combined $104 million connected to two other virtual currency heists.
The mixer was designated pursuant to E.O. 13694 ("Blocking the Property of Certain Persons Engaging in Significant Malicious Cyber-Enabled Activities") for materially assisting in cyber-enabled activities that are reasonably likely to result in a significant threat to the national security, foreign policy, economic health or financial stability of the United States. The designation follows a previous OFAC designation of virtual currency mixer Blender.io (see previous coverage). Treasury and OFAC stated that they will "continue to investigate the use of mixers for illicit purposes and use its authorities to respond to illicit financing risks in the virtual currency ecosystem."
Commentary
Tornado Cash is a decentralized technology protocol. All of its code is open-source and will exist as smart contracts on the Ethereum blockchain for as long as the Ethereum blockchain exists. Neither the United States, nor any other jurisdiction can halt the operation of those smart contracts or seize assets from them. Instead, the only legal effects of sanctioning Tornado Cash seem to be that (i) U.S.-based servers cannot point to it and (ii) it is illegal for U.S. persons to interact with it. As a practical matter, non-U.S. persons might also be reluctant to interact with a protocol that is sanctioned by OFAC.
Blockchains are transparent, meaning anyone who knows someone's crypto wallet public key can see all assets contained there. Tornado Cash is a useful tool for reacquiring anonymity after a wallet's public key has been revealed to others. OFAC's decision to sanction Tornado Cash makes it harder for U.S. persons to keep their personal finances private, and it does not actually stop terrorists and scammers from using the protocol to launder funds.
The decision also raises the question of whether other decentralized protocols - in particular, those used in decentralized finance ("DeFi") - might in the future face similar sanctions. Very broadly, DeFi protocols disintermediate transactions that traditionally are conducted by financial institutions, such as lending, market-making and insurance, by enabling anonymous market participants to contribute liquidity to smart contracts that conduct those transactions algorithmically with customers. OFAC's decision to sanction Tornado Cash will have many members of the DeFi community wondering whether a similar fate might befall protocols designed to facilitate financial transactions in a permissionless, censorship-resistant environment that enables participation by anyone in the world, including sanctioned individuals.
As more financial transactions move on-chain, governments worldwide will have to consider what balance to strike between financial privacy and the free flow of capital and the desire to curtail money laundering and the funding of terrorism. Meanwhile, as cryptography-based blockchain tech continues to improve, regulators could find themselves in an arms race against developers of anonymity-preserving retail products.
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