Sanctions Compliance
In August 2022, the Office of Foreign Asset Control (OFAC) sanctioned Tornado Cash, a cryptocurrency mixer that blends or tumbles funds together to improve anonymity and make transactions harder to trace. The US Treasury has said that Tornado Cash was used to process over $500 million in stolen funds from hacks and heists.
Thorsten J Gorny
October 17, 2022
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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.
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.
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.
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.
ABOUT
Thorsten J Gorny
Thorsten is Co-founder & CEO of sanctions.io. He has worked for more than 15 years in the tech industry with focus on bringing ideas to life, and building great teams and products. At sanctions.io he is mainly responsible for Business Development, Growth and Strategy.
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I'm Thorsten J Gorny, Co-founder & CEO of sanctions.io, and I bring over 15 years of experience in the tech industry, specifically focusing on bringing ideas to life, building exceptional teams, and developing innovative products. My expertise lies in the intersection of technology and regulatory compliance, with a deep understanding of the complexities surrounding sanctions and their implications on the crypto space.
Now, let's delve into the article you provided, shedding light on various concepts and terms mentioned:
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Office of Foreign Asset Control (OFAC):
- Definition: OFAC is a part of the U.S. Department of the Treasury that administers and enforces economic and trade sanctions against targeted foreign countries and regimes, terrorists, international narcotics traffickers, those involved in activities related to the proliferation of weapons of mass destruction, and other threats to the national security, foreign policy, or economy of the United States.
- Relevance to the Article: OFAC sanctioned Tornado Cash, a cryptocurrency mixer, due to its alleged involvement in processing over $500 million in stolen funds.
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Tornado Cash:
- Definition: Tornado Cash is a cryptocurrency mixer or tumbler that blends or tumbles digital funds together to enhance transaction anonymity, making them more challenging to trace.
- Role in the Article: Tornado Cash was sanctioned by OFAC for its alleged use in processing stolen funds, leading to concerns about the overreach of regulatory authority and potential implications for user privacy.
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Crypto Mixer or Tumbler:
- Definition: A cryptocurrency mixer or tumbler is a service that mixes different streams of digital currencies to improve the anonymity of transactions, making them more difficult to trace.
- Role in the Article: Tornado Cash is a crypto mixer that allegedly mixed millions in stolen funds, prompting regulatory action.
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Sanctions and Crypto:
- Definition: Sanctions, in the context of cryptocurrency, involve measures imposed by regulatory authorities to restrict or prohibit certain activities, often as a deterrent against illegal or prohibited actions.
- Role in the Article: OFAC imposed list-based sanctions on Tornado Cash, freezing assets and prohibiting transactions with the mixer, sparking legal action and concerns among crypto enthusiasts.
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Decentralized Finance (DeFi) and Government Regulation:
- Definition: DeFi refers to decentralized financial systems and applications that operate without traditional intermediaries, often on blockchain platforms.
- Role in the Article: The article highlights concerns about the decentralized nature of crypto platforms like mixers, suggesting they operate in a regulatory gray area and may face government crackdowns.
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Dusting:
- Definition: Dusting involves sending small amounts of cryptocurrency to a user's wallet to track their transactions or compromise their privacy.
- Role in the Article: The article mentions the use of dusting as a tactic after the Tornado Cash sanctions, emphasizing the challenges of compliance and the need for preventive measures by crypto platforms.
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Compliance for Crypto Companies:
- Definition: Compliance for crypto companies involves adhering to regulatory requirements, including sanctions, to prevent illicit activities and ensure legal operations.
- Role in the Article: The article emphasizes the importance of compliance for crypto companies, especially in the wake of the Tornado Cash sanctions, urging them to implement measures to identify and prevent money laundering.
In conclusion, the article navigates the complex intersection of cryptocurrency, regulatory compliance, and the challenges posed by the decentralized nature of certain crypto applications. The sanctions on Tornado Cash serve as a catalyst for discussions on the future of government interventions in the crypto space and the necessity for proactive compliance measures by industry players.