The US Treasury imposes sanctions on the “Tornado Cash” smart contract on Ethereum. The ecosystem reacts with indignation but not surprise, and influential companies submit. This could be the baptism of fire for the smart contract.
Everything happens for the first time. The US Treasury Department today announced it is sanctioning the Tornado Cash mixer for laundering more than $7 billion worth of virtual currencies.
For example: $7.8 million from last week's Nomad hack, $96 from June's Harmony Bridge hack, $455 million from the Lazarus Group, a hacking group serving the North Korean government.
So far, so clear. Criminals use blenders and the US government is prosecuting them. If it has the means to apprehend them, it takes action, if not, it imposes sanctions. No surprise at this point.
Things get interesting when we look at Tornado Cash . Because this is not a service provider, like a mixer, but a smart contract. Tornado Cash itself does not exist in space. It forms a decentralized autonomous organization (DAO).
The mother of all DeFis
Ethics aside, it's sad that Tornado Cash may have to die. Because technically the DAO is fascinating:
On the one hand there are liquidity pools: You pay certain amounts into the DAO and then get them out again with another account. With clever denominations, absolutely no trace is left on the blockchain. Tornado Cash works like a classic blender in this respect.
With a classic mixer, however, the liquidity is provided by a central party. Tornado has no central party; therefore, in their stead, members of the DAO issue ethers, stablecoins and tokens in liquidity pools and receive fees in return. They do “liquidity mining.” Basically, Tornado Cash is the mother of all DeFis.
But one problem remains: How does the DAO know that you have deposited something? How to prove this without revealing the original address? With a classic mixer, encrypted messages would be exchanged. This is not possible on chain.
This is where zero-knowledge proofs come in: They allow you to prove that you know something - such as a signature - without revealing it. It's far beyond my cryptographic horizons, but it looks like it works reliably: you prove you have control of one of the addresses that deposited funds without revealing which one.
Until mid-2020, the developers controlled the liquidity pools through the admin addresses. Then they set the admin addresses to 0x0000000000000000000000000000000000000000000000 in the Smart Contracts – the classic burn address in Ethereum.
The smart contracts are thus demonstrably unchangeable and unstoppable. Nobody is in control. As long as the Ethereum blockchain is up, Tornado Cash is unstoppable like a thunderstorm.
The sanctions
The US government seems to be acknowledging that Tornado Cash only exists in cyberspace. There is no one to arrest, no server to shut down, no smart contract to delete. Tornado Cash is unattainable.
But since a virtual currency mixer poses a “national security threat,” the government must do something: impose sanctions, like foreign criminals. The Treasury blacklists a number of Ethereum addresses, including the addresses of all liquidity pools. This has the following consequences:
Tornado Cash assets located in the US or held by US citizens will be blocked and must be reported.
Companies that are 50 percent owned by blocked individuals or entities should also be blocked.
Americans are prohibited from interacting with blocked entities.
In short, no one who lives in the US, is a US citizen, or does business with a US citizen should send money to Tornado Cash or receive money from the DAO, and if they have done so in the past, they may have a problem.
It is forbidden to withdraw money that is in a liquidity pool. Presumably it is even forbidden to receive money that someone has paid out from such a pool.
The impacts
Apparently, the Treasury Department coordinated in advance with many large companies in the US: Tornado Cash's lights went out on the same day it issued the announcement.
First, the website went offline, probably because the provider blocked it. Github followed suit and blocked Tornado's software repository.
In itself that shouldn't be a problem. That's exactly what Tornado was made for: as an unstoppable smart contract that also works without a website. You could call it an ordeal by fire, and right now it doesn't look like Tornado will pass.
Because an Ethereum node is quite a monster, most users use Infura or Alchemy nodes indirectly through their wallet. These two companies started blocking RPC requests to Tornado today. The wallets cannot be easily interacted with with Tornado's smart contracts.
Of course: Tornado Cash is alive. The smart contract is still there. You can bypass the blockade because it's only in the frontend. But who does that? Commercially, that could have been the death knell.
But it goes even further: Center, the issuer of the USDC stablecoin, promptly blacklisted all addresses associated with Tornado in the token's smart contract. $75,000 is frozen, not off-chain, but on-chain: with the unstoppability of the smart contract. Blockchains can be a sharp sword for regulators, and Center is happy to hold it.
How it goes on
By sanctioning a DAO, the US Treasury is breaking new ground. While the smart contract lives up to its promise that you can't turn it off, the sanctions hit hard.
This is tragic, especially with Ethereum, because privacy is sorely needed. Unlike Bitcoin, it is common for Ethereum to use an address over and over again and to identify yourself with it on DAPPs. Tornado Cash may have been used by criminals, but it should be used by everyone.
The sanctions validate those who say true privacy cannot be optional. When all transactions are private - like Monero - sanctions and blacklists have no clue. Privacy as a service, on the other hand, whether through a mixer or smart contract, makes it possible to sanction the service.
How will it go on? Maybe Tornado Cash will recover. The smart contract continues to run. Maybe wallets will become more decentralized because of the incident, maybe the blockchain will become more manageable with the merge, maybe wallets will improve their data protection, maybe anonymous rollups and sidechains will come into play. The cat and mouse game is far from over.
However, we now know one thing: smart contracts and DAOs have to live with becoming the potential object of financial sanctions. Puppy protection is over.
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