What does the sanction of the mixer Tornado mean for the DeFi market?

On August 9, 2022, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) announced sanctions against mixer Tornado Cash, adding Tornado Cash to the Specially Designated Nationals (SDN) list, which specifically identified 38 cryptocurrency addresses.

As a result of today’s action, all Tornado Cash property and property interests in the United States or owned or controlled by Americans are frozen and must be reported to OFAC, the U.S. Treasury said. In addition, any entity that is 50% or more directly or indirectly owned by one or more of the blocked persons will also be blocked. Unless authorized or exempted by a general or specific license issued by OFAC, all transactions by U.S. persons or within (or in transit) of the United States involving any property or interest in property of persons designated or otherwise prevented are prohibited. These prohibitions include making any donations or providing funds, goods or services by or for the benefit of any blocked person, and accepting any donations or providing funds, goods or services.

Affected by this incident, USDC issuer Circle has officially blacklisted Ethereum addresses from the U.S. Treasury Department’s sanctions list.

Antonio, founder of dYdX, commented that Circle’s blacklisting of Ethereum addresses on the sanctions list without prior notification is a dangerous precedent. It’s almost a worst-case scenario for a protocol to exclude its users’ assets from their blacklists.

Antonio said the U.S. Treasury Department is effectively banning technology . Don’t blame Circle for doing this, probably they have no choice. dYdX also currently implements sanctions checks on its hosted matching engine and must block these addresses as well. At the same time, Antonio said that he is not calling for a boycott of USDC/USDT, etc. The centralized stablecoin has very superior network effects and liquidity, and will not disappear soon. But this is a watershed moment for open source technology and underscores the long-term importance of building a more decentralized future.

So what does the U.S. Treasury sanctions on coin mixer Tornado mean for the crypto market? DeFi education KOL @BowTiedIguana analyzed this in detail:

OFAC = Office of Foreign Assets Control. They administer and enforce sanctions against prominent individuals, including major international terrorists, drug traffickers, and financial/political elites in certain countries deemed hostile to U.S. interests. OFAC ensures that Americans cannot legally do business with Cuba, Iran, Iraq, North Korea, and other countries without specific government approval. OFAC maintains a Specially Designated Nationals and Blocked Persons List (SDN List).

On August 8, 2022, Tornado Cash and all Ethereum wallet addresses associated with Tornado Cash and its smart contracts were added to OFAC’s SDN list. All Tornado Cash is blocked (not available to Americans), including their @Gitcoin grant wallet. We grabbed wallet information from Etherscan – here are all their addresses, totaling $437 million in stablecoins, ETH and WBTC.

VeuFjYnNInxFVWNbjZzQ0doS3GyAMP8w4pvEku5l.pngIt is against the law for *any* US “person” to conduct trade, economic transactions or “other transactions” with any person, company or country on the SDN List. This now includes using Tornado Cash. An American is any citizen, resident or corporation of the United States.

Fines, civil and criminal penalties can exceed millions of dollars. The maximum civil penalty for a “non-serious case” is $330,947. Violations carry a maximum prison term of 30 years. “Other deals” is fairly broad. The government guidance states that it may include “technical transactions, such as downloading software patches from sanctioned entities”. At this point, it may be illegal for Americans to visit the Tornado website.

Blocking immediately and completely prohibits any transfer or transaction of Tornado Cash property. For WBTC, USDC, USDT, we expect the issuer to take all technical measures to prevent anyone from transferring or redeeming these assets.

Circle’s USDC can be frozen at the smart contract level. A list of banned addresses can be seen on Dune.

hU3QZCxK75HAGcKyYcDpEdCGBGxkXvfXa9qtho6K.png

Tether’s USDT can also be blacklisted at the Ethereum smart contract level. A list of banned addresses can be seen on Dune. *Not yet* Tornado added.

TKWmBiedDldr9HRpR7p8yTxl1ERECEtH7rQsOdKG.png

WBTC is issued by BitGo. Its entities are located in South Dakota and New York. They must comply with OFAC sanctions or their executives face millions of dollars in fines and jail time.

Therefore, we want them to suspend redemption of tainted WBTC, making these tokens worthless. If liquidity providers don’t *immediately* withdraw liquidity from DEXs, they could end up as holders of blocked WBTC (and stablecoins) assets.

What does this mean for Ethereum miners and stakers as Americans? There’s no legal precedent that we know of, and we’re not lawyers, but that doesn’t look good.

It appears that OFAC sanctions could be violated if a miner or validator generates (or validates) an Ethereum block containing a transaction that contains one of the Ethereum addresses on the SDN list. However, how to do it is unclear.

Speculation: The Ethereum client software may be updated with an optional patch that allows miners/validators to ignore tainted mempool transactions to avoid violating sanctions. Transaction review is not popular, but we can see this being done in-house by large US miners/stakers.

This could be a risk for any U.S. fund investing in Ethereum proof-of-stake , as voting for blocks containing illegal transactions could be an illegal activity. We anticipate either taking a technical countermeasure (voluntary review) or moving operations outside of US jurisdiction. CEX is expected to use its chain analysis software to block and report all sanctions-violating customer transactions. This means anyone withdrawing money from Tornado Cash and trying to withdraw through a US-related CEX.

A non-U.S. branch of an exchange is a separate legal entity, but can be considered a de facto “foreign branch” of a U.S. entity. Exchanges are strongly encouraged to ensure that their foreign-registered group companies are also in full compliance with OFAC sanctions.

All in all, the U.S. is willing to use the highest level of economic sanctions typically reserved for foreign powers and extremely dangerous individuals against privacy products in cryptocurrencies.

If you are American, any interaction with Tornado Cash may be illegal – including Gitcoin donations, working on the project, running or downloading its software, visiting its website, and depositing/withdrawing money from smart contracts.

As of August 8, all assets in Tornado have been tainted. Tether, Circle and BitGo will refuse to exchange these tokens. In any case, tokens are likely to be withdrawn from TC and transferred to liquidity pools. Liquidity providers will be left behind.

Out of the issuer’s (Circle, Tether, BitGo) discretion, there is little risk to DEX pools of these tainted assets .

Americans running ethereum mining or staking businesses may face legal risks – these businesses may self-censor transactions or move offshore DeFi protocols outside of DEXs ) employees may also be exposed to legal risks.

Delphi Digital general counsel @lex_node said that if there are funds in Tornado Cash, it is recommended to leave them where they are and consult a lawyer – perhaps applying for special permission to withdraw them would be a safer way. If there are funds or addresses that have interacted with Tornado Cash before, the best guess is that they are not required by law to be blocked – but it is never known when CEXs might engage in possible “over-compliance” as the answer may not be clear At the same time they may want zero risk. As for those considering forking Tornado Cash as a vulnerability, beware, the sanctions are vague about Tornado Cash, and redeployment may be seen as a sanction violation and become a SAFU.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/what-does-the-sanction-of-the-mixer-tornado-mean-for-the-defi-market/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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