The many consequences of sanctions against Tornado Cash

 

A developer is arrested, scores of DAPPS enforce the blacklist, and a "Duster" ensures the sanctions punish 999 innocent people so a guilty one doesn't get away. We report on these ramifications and more - and explore some of the exciting questions that arise.

The US Treasury sanctions list for Ethereum DAO Tornado Cash could be a game changer for Ethereum in particular and cryptocurrencies in general.

First of all, however, the action had a number of unpleasant after-effects, each of which gives cause for reflection and to question some beliefs that were believed to be certain. These episodes, as we'll see at the end, raise a lot of questions - including heretical ones - that don't have clear answers as of this writing.

We are in uncharted and uncharted territory.

The developer was arrested in the Netherlands

A developer of Tornado Cash, on the other hand, is now in a Dutch prison cell.

On Friday, Dutch police arrested a 29-year-old man they accused of helping to launder money via Tornado. The community speculated that it was the developer Alexey Pertsev, which was confirmed shortly afterwards by his wife . Pertsev will now spend 14 days in custody and then appear before the judge.

It is difficult to determine exactly what he is being accused of. He is suspected, writes the FIOD , the agency responsible for financial crimes, “of involvement in concealing criminal financial flows and promoting money laundering through the decentralized Ethereum mixing service Tornade Cash.”

However, it is currently unknown whether Pertsev was arrested solely for developing open-source software, as the community suspects with horror. This would be a devastating signal, as it would massively undermine legal security in development. Where will the line be drawn? At what point does one make oneself liable to prosecution if software that one helps to develop is also used by criminals?

And how does that square with regulation that in both the EU and US tends not to regulate pure software development, knowing what a Pandora's box it's opening?

Presumably, however, Pertsev also made money from the fact that money was laundered via Tornado Cash, for example by providing liquidity or enriching himself from the issuance of the TRON token. This is suggested by a brief sentence in the FIOD press release: "There are suspicions that the people behind this organization have made massive profits from these transactions." Developing might be fine, but using your development in a profitable way is not.

However, this offense - aiding and abetting money laundering for the purpose of generating income - could, like Al Capone's tax evasion, be merely an excuse to punish an otherwise unjustifiable offense - the development of software - and thus set an example to state: Beware software developers, what you are doing is not strictly forbidden, but be careful as we will still pursue you if you write code that we don't like - and believe us, we will find a rope that we will around your neck!

The FIOD threatens that further arrests cannot be ruled out. "These advanced technologies, such as decentralized organizations that can facilitate money laundering," received special attention from the agency.

Most dapps go with it

Although the Ethereum community is protesting loudly on all social media, for example by making the Tornado Cash logo an avatar, the ecosystem itself makes it easy for the Ministry of Finance to enforce the sanctions. It costs nothing to complain, but to fight back can hurt.

For example, the boss of the Coinbase exchange protests on Twitter that sanctioning a technology sets a bad precedent and should be challenged. “Obviously,” however, Coinbase always follows the law.

As previously described, node providers Infura and Alchemy have blocked RPC requests for Tornado Cash, GitHub has deleted the DAPP's repository, and stablecoin USDC has blacklisted the sanctioned addresses. This alone could be considered a devastating blow.

Numerous other Dapps and providers are now following: the Pocket Network , another infrastructure operator that also calls itself DAO, but is actually a US company. In addition, the DeFi DAPPs Balancer, Uniswap, dYdX, Aave, Ren and Oasis and others. After Tornado Cash was included in the sanctions lists, things are happening very quickly. The Ministry of Finance demonstrates how to rule on a blockchain.

In the background appears to be TRM Labs, a digital asset compliance startup that may have been involved in the Tornado investigation. TRM states that 41 percent of all tokens deposited in Tornado Cash in June and July are linked to hacks and thefts. The startup offers an API through which crypto exchanges and DeFi DAPPs can implement the blacklist of the US Treasury Department. The collaboration between TRM and Treasury may explain why the ecosystem implemented the sanctions just hours after they were announced.

The presence of the TRM API in dapps open source code serves as a surefire indication that they are enforcing the sanctions.

Of course, all these “dapps” are only the front end of the smart contracts. As a rule, they do not have the opportunity to implement blacklists. But for most users this doesn't change anything. You need node providers and frontends to use dapps. The few geeks who can do this themselves don't create the liquidity and volume for serious financial applications.

So the lesson the Ethereum scene is learning is this: As long as neither nodes nor frontends for dapps are decentralized, they can be sanctioned and regulated just as much as centralized companies. It doesn't do much good to have real decentralization in the basement if the door to it is bolted so tightly that no guest can find their way down.

The frontends of the Maker DAO, such as Oasis, also follow the sanctions. At the same time, however, members are aware of the potentially devastating consequences. Because the stablecoin DAI issued by Maker is covered to a not inconsiderable extent by the stablecoin USDC. If Center now freezes USDC, which serves as collateral for DAI dollars, it will endanger the stability of the stablecoin. That doesn't appear to have happened with Tornado Cash, but the very prospect is ominous.

Therefore , the Maker DAO is currently discussing mining the amount of USDC in the treasury. Whether these should be replaced by Ethereum alone or by other "Real World Assets" (RWA) is still open.

A troll takes the sanctions ad absurdum

An original troll showed how absurd the sanctions are. Someone who appeared to have ether in Tornado Cash sent it in small batches to hundreds of people who have made their wallets public, whether as an address or through the Ethereum Name Service (ENS).

This is called "Dusten", from the English word for dust, which in Bitcoin refers to microtransactions that are sometimes used to haunt users.

Recipients of the dust particles from Tornado include Coinbase CEO Brian Armstrong, Tron founder Justin Sun, Youtuber Logan Paul, artist Beeple, influencer Anthony Sassal and the donation address of Ukraine.

The consequences were exactly what one could have feared. The APIs or algorithms that dapps use to implement the blacklists could not help but now also include the involuntarily gifted addresses.

For example, Anthony Sassal could no longer log into Aave because his address was blocked. Even Justin Sun felt the same way, and probably dozens of other users.

The "dusting" of the well-known addresses is an expensive but ingenious move. Because it is difficult if not impossible for the blacklists and dapp providers to recognize which addresses have now received ether from Tornado Cash because their owner has laundered money - and which addresses have only been the victim of this prank.

With dusting, a principle of the rule of law is turned on its head: instead of 999 guilty people getting away with it, so that no innocent person is punished, 999 innocent people are now being punished, so that not one guilty person gets away scot-free. If you scale this equation, it quickly becomes apparent that such traditional blacklisting is hardly compatible with blockchains - and especially decentralized applications. Sooner or later, it will take the entire blockchain hostage.

And now?

It's far too early to talk about all the many ramifications that the sanctions against Tornado Cash pose.

Will the merge that moves Ethereum from Proof of Work to Proof of Stake make things worse or better? If central entities like exchanges hold the majority of the coins – will they then implement sanctions at the protocol level so that not only the front end is affected, but affected transactions are actually no longer confirmed?

Or will the merge more decentralize block production and make it easier to run a node to become independent of “infrastructure providers”?

Will the Ethereum community find some kind of best practice to make smart contracts more resistant to blacklists? Will it help not to host the frontends centrally, but decentrally, for example in the Interplanetary File System (IPFS)?

Will the regulator issue clear rules on how startups and developers have to deal with the sanctions? And will these rules ensure that the contagion effects remain mild, so that 999 innocent people are not taken hostage?

And finally, a final heretical question: will Ethereum possibly benefit from blacklisting and sanctions being automated and possibly also enforced at the level of the smart contracts themselves? Will this make Ethereum the home of a financial system that is not only meant to be non-criminal—but cannot be criminal at all?

Will this result in the first ever finance that is completely transparent, fair and honest? Will Ethereum or "Blockchain" or "DeFi" become the gold standard of regulation - and will banks and financial service providers even be required to operate with smart contracts at some point?

But who decides what is criminal? Will Ethereum become a US blockchain? What disadvantages does this pose? And do these outweigh the benefits?

These are just some of the questions being asked at this turning point in Ethereum's history. We are entering uncharted waters.

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