Treasury Designates Tornado Cash
On Monday, the Office of Foreign Assets Controls (OFAC), the Treasury Department agency tasked with preventing sanctions violations, added the DeFi protocol Tornado Cash to its Specially Designated Nationals (SDN) list.
That means no U.S. persons or entities are allowed to interact with a list of smart contracts associated with the project. According to the Treasury Department report, Tornado Cash had been a key tool used by Lazarus Group, a North Korean hacking group responsible for the $625 million hack of Axie Infinity’s Ronin Network in March.
Law enforcement agencies have long been on the record about their concern that privacy enhancing smart contracts and cryptocurrencies pose high money-laundering risks. While Treasury has sanctioned centralized mixing services in the past (Blender.io), this is the first time a US law enforcement agency has directly targeted an open-source and immutable software program.
And it may signal a new approach as opposed to a unique occurrence. A “senior Treasury Department official” told Coindesk that “we do believe that this action will send a really critical message to the private sector about the risks associated with mixers writ large, which obviously is designed to inhibit Tornado Cash or any sort of reconstituted versions of it to continue to operate” (emphasis added).
What does this mean?
While Tornado’s designation certainly represents a “Rubicon” moment for crypto, there are many outstanding questions that will need clarification given the novelty of the situation. Before Monday, OFAC’s SDN list targeted people or “entities” and their associated assets, be they bank accounts, planes, or even ships. For the first time, however, the list now specifically targets a series of smart contracts directly.
There’s been a lot of commentary on this situation this week, but we do want to note one issue. The “dusting” of several ETH wallets via a designated Tornado contract caused a lot of stir on Twitter and catalyzed discussions of liability. This opinion from Magistrate Judge Zia Faruqui provides a good overview of the sanctions regime and liability for violations, and we want to highlight these quotes:
“Criminal penalties may arise from willful violations, while civil penalties are imposed on a strict liability basis” (emphasis added).
“U.S. persons are prohibited from participating in or facilitating transactions, even if ultimately concluded by foreign persons, which would be prohibited if performed by the U.S. person directly.”
“Non-U.S. persons or entities are liable for sanctions violations when they cause a U.S. person or entity to violate OFAC’s regulations.”
At the very least, the industry and users need and deserve clarity with respect to Treasury’s thinking on this designation and how US persons are expected to comply with it given the idiosyncrasies of digital asset transactions. To start, we’ve submitted a Freedom of Information Act request to Treasury, will be asking Treasury to issue responses to FAQs that will help US persons comply with the designation, and advocating for Treasury to issue a “general license” so that US persons who were using Tornado contracts for legitimate and lawful purposes may recover their “locked up” assets from the contracts without breaking the law.
Lawmakers Urge Fed to Speed Up CBDC Efforts
On Monday, the Wall Street Journal reported that a group of lawmakers, including Chair of the House Financial Services Committee Maxine Waters (D-CA) and Rep. French Hill (R-AR), had signaled to the Federal Reserve that it should speed up efforts to issue a central bank digital currency (CBDC).
The lawmakers cited concerns that China’s head start on rolling out this technology may endanger the U.S. dollar’s position as the world’s reserve currency. Waters described this effort as “a new digital assets space race.”
In his previous statements, Fed Chairman Jerome Powell has made it clear he would “rather get it right” than “be first.” Similarly, Fed Vice Chairwoman Lael Brainard suggested to the House Financial Services Committee that the roll out of a CBDC would take at least five years.
What does this mean?
There’s nothing close to consensus in Congress on the idea of the Fed issuing a CBDC. Some lawmakers, like Waters and Hill, see the development of a CBDC as a geopolitical imperative in order to compete with similar efforts in China and other countries and have advocated for legislation that authorizes specific agencies to begin this process.
Others, like Rep. Warren Davidson (R-OH) and Rep. Tom Emmer (R-MN), are skeptical because of the civil liberty and privacy implications that a CBDC raises. These lawmakers have advocated that the government embrace alternatives like well-regulated, privately issued stablecoins and leave technological innovation to the private sector.
Our take: let’s check back in on this debate in 2030.
UK Parliament Launches Crypto Inquiry
Last week, The Crypto and Digital Assets All Party Parliamentary Group (APPG) began its inquiry into the UK’s crypto industry, focusing on how to properly regulate the space.
The group stated that it seeks to develop a report with policy and regulatory recommendations that it will share with regulators in pursuance of a framework for this novel technology. The group has said that it will engage with industry representatives, businesses, regulators, and other officials to gather a wide-range of perspectives on the UK’s current and future approach to regulating digital assets.
The topics the group will deal with include concerns related to preventing illicit activity, the potential for a CBDC, the roles different regulators have to play, and the standards innovators should adhere to when developing these protocols and assets.
Member of Parliament Lisa Cameron, a Scottish National Party representative in Parliament and chairwoman of the APPG said the following about the group’s efforts: "It's vital that the U.K. does not take its foot off the gas and that government and regulators keep to their commitments when it comes to crypto and digital assets.”
What does this mean?
We’ll always be supportive of more engagement with regulators and governments, which is the only path to eventually end up with good policy. For DeFi, it is imperative that policies account for the key differences between non-custodial and peer-to-peer activities as opposed to intermediated services, be they in the traditional or crypto financial worlds.