OFAC

Coinbase supports new court action to remove Tornado Cash ban

The motion is part of a broader effort to restore internet privacy rights for United States citizens.

The United States Treasury faces a renewed legal challenge that aims to overturn the decision to sanction the crypto mixer Tornado Cash, filed by six individuals backed by the cryptocurrency exchange Coinbase.

A motion for a partial summary judgment was filed on April 5 in a Texas District Court, with the Coinbase-backed plaintiffs moving for the U.S. Office of Foreign Asset Control (OFAC) to settle for the first two counts from its original complaint filed in September 2022.

If granted, it would see the judge rule on some of the factual issues while leaving others for the trial.

The counts claimed OFAC exceeded its statutory powers under the International Emergency Economic Powers Act (IEEPA) and violated the free speech clause of the U.S. Constitution’s First Amendment.

The plaintiffs firstly claimed that OFAC breached a section of the IEEPA that allows the Treasury to take action against the property in which a foreign country or foreign national has an interest.

The motion argued that as the provision only allows the pursuit of property-related action against a foreign “national” or “person,” it doesn’t apply to open-source software.

To strengthen its claim, the plaintiffs argued the 20 or so smart contracts that provide the functionality to Tornado Cash should not be considered property under IEEPA because they cannot be owned:

“An immutable smart contract is incapable of being owned, it is not property and the Department lacks authority under IEEPA and the North Korea Act to prohibit transactions with those smart contracts.”

“No one has the right to alter them. No one has the right to delete them,” they added.

The second main argument put forth is that by banning the open-source code, OFAC is violating the free speech clause of the First Amendment to the U.S. Constitution.

Related: Treasury officials would have done more for national security by leaving Tornado Cash alone

The plaintiffs noted OFAC has the authority to take action against “crypto thieves” like North Korea’s Lazarus Group, but a “total prohibition is thus grossly disproportionate,” as money laundering only accounted for 0.05% of crypto transactions in 2021.

“To ban all uses of Tornado Cash is akin to banning the printing press because a tiny fraction of users might publish instructions on how to build a nuclear weapon,” they added.

The motivation behind the motion is part of a broader effort to restore internet privacy rights for U.S. citizens, the plaintiffs explained. It is the most recent filing since the individuals first sued the U.S. Department of Treasury in September.

The six plaintiffs behind the filing are Joseph Van Loon, Tyler Almeida, Alexander Fisher, Preston Van Loon, Kevin Vitale and Nate Welch. The filing details that most of the group had previously interacted with Tornado Cash.

The legal battle comes as Alexey Pertsev, the creator of Tornado Cash, faces his own troubles in The Netherlands. He has been held since Aug. 18 on a series of money laundering charges.

Magazine: Unstablecoins: Depegging, bank runs and other risks loom

Treasury officials would have done more for national security by leaving Tornado Cash alone

Tornado Cash contributes to our national security interests more than it undermines them.

One of the most powerful moments in a new crypto user’s journey happens the first time they send a sizable amount of money to their private wallet. It’s an awe-inspiring, serious moment — and it’s a little scary to experience the power and personal responsibility of the technology firsthand with your own real money.

A second powerful moment occurs when the same user is introduced to a block explorer, looks up their address and sees that same transaction there on the blockchain for all to see.

There are competing visions of what Bitcoin (BTC), Ether (ETH) and other cryptocurrencies will achieve. They may be the future of gold, payments, currency or bank accounts. But no matter your crypto vision, none can work without achieving the same level of privacy enjoyed by cash or, at a minimum, credit cards. While credit card companies conduct unparalleled surveillance on our financial life, at least our transactions are not viewable on a public ledger.

There are a number of tools to achieve privacy available in crypto, from privacy coins to mixers and conjoining transactions on the Bitcoin blockchain. These tools are used by everyday users, and in some cases, they are used by bad actors — just like cash. Or to be more precise, crypto and crypto privacy tools are used by criminals with less frequency than cash.

The United States Treasury Department’s Office of Foreign Assets Control sanctioned one particular project, Tornado Cash, that was the most effective privacy tool on Ethereum. Much has been written about the sanction and the threat represented by sanctioning code as speech, and two lawsuits have been filed to push back against OFAC’s efforts.

What has been lost in the FTX drama over the last few weeks is the deft maneuvering that OFAC has engaged in to improve its strategic position in the litigation. On Nov. 8, OFAC “redesignated” Tornado Cash “on the basis of new information.”

Two significant legal challenges brought forward a few weeks prior that poked holes in OFAC’s designation are the likely source of the “new information.” OFAC can only sanction groups, not computer code, and OFAC seems to be pushing a novel theory in its second designation that the decentralized autonomous organization around Tornado Cash was part of a group, even though the DAO had no power to change the code since the admin key was burned.

Supporters of the designation argue it was overall a fair trade to achieve national security goals. The stated reason for the designation was that Tornado Cash “obfuscated the movement of over $455 million stolen in March 2022” by North Korean hackers.

But did it really? Privacy tools require a large anonymity set to work. That’s the only way that small transactions by ordinary users can hide in a large crowd. And it works only if privacy tools are used correctly, without privacy mistakes like making mirror transfers into and out of shielded assets within a short timeframe.

Related: My story of telling the SEC ‘I told you so’ on FTX

Consider that when North Korean hackers made that specific transfer, it represented 20% of the entire Tornado Cash pool. The sheer volume of ETH North Korea was trying to move through the Tornado Cash protocol meant that it wasn’t obtaining any meaningful privacy by using the tool. It evokes a comical vision of Godzilla trying to cover himself with a fig leaf.

The Treasury Department would have achieved more for national security by allowing North Korean hackers to maintain a false sense of confidence and continue using the tool while it surveilled their transactions using statistical tracing analysis. What OFAC achieved instead amounts to little more than national security theater.

Meanwhile, it has done real harm to the Ethereum blockchain. One example, as noted by Ethereum co-founder Vitalik Buterin, is that Tornado Cash anonymized donations to support Ukraine. If the Treasury Department’s sanction against Tornado Cash is allowed to stand, it can sanction anything from computer code and applications to specific assets.

Related: Coinbase is fighting back as the SEC closes in on Tornado Cash

Almost as if on cue, former Treasury official Juan Zarate argued in a recent interview that the Treasury Department should use the Patriot Act more “creatively” to sanction entire classes of assets in crypto. It’s a short step from there to sanctioning gold coins or other everyday assets.

Society doesn’t countenance the sanctioning of things merely because criminals happen to use them. Criminals drive on roads. They use tools available at the hardware store. They use these things in furtherance of their crimes.

If OFAC’s vague sanction of “Tornado Cash” is allowed to stand, it can sanction any protocol or asset in crypto. And that threatens to destroy any meaningful vision of crypto’s future.

J. W. Verret is an associate professor at the George Mason Law School. He is a practicing crypto forensic accountant and also practices securities law at Lawrence Law LLC. He is a member of the Financial Accounting Standards Board’s Advisory Council, a member of the Zcash Foundation’s board of directors, and a former member of the SEC Investor Advisory Committee. He also leads the Crypto Freedom Lab, a think tank fighting for policy change to preserve freedom and privacy for crypto developers and users.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

45% of ETH validators now complying with US sanctions — Labrys CEO

Labrys CEO Lachlan Feeney is trying to raise awareness among validators running Flashbots’ software that they may potentially be contributing to censorship within the Ethereum network.

According to the CEO of blockchain development agency Labrys, Lachan Feeney, approximately 45% of all Ethereum blocks currently being validated run MEV-boost relay flashbots and comply with United States sanctions.

Speaking to Cointelegraph in an interview on Sept. 30, Feeney noted that while reports have stated that 25% of all blocks validated since the Merge complies with United States sanctions, this is a lagging indicator and the current number is likely to be closer to one out of every two blocks.

Feeney pointed out that MEV-Boost relays are regulated businesses, often U.S.-based, and are “censoring certain transactions in the blocks that they build, particularly transactions from Tornado Cash.”

The CEO also pointed out validators have a financial incentive to use MEV-Boost relays, which would drive an uptick in their usage, noting:

“The issue, is that from the validators perspective, these guys are paying them to sort of do this. So if you want to make more money, you just turn this feature on and as a validator, you sort of boost your yield.”

MEV-Boost relays are centralized entities dedicated to efficient Maximal Extractable Value (MEV) extraction. With Flashbots being the most popular, MEV-Boost relays effectively allow validators to outsource block production and sell the right to build a block to the highest bidder.

Labrys released an MEV Watch tool on Sept. 28, which can inform validators about which MEV-Boost relays comply with Office of Foreign Assets Control (OFAC) sanctions. Referring to the motivation behind the tool, Feeney said:

“We’re just trying to raise some awareness for those who are unaware that by running this software, they are potentially contributing to censorship of the network.”

Feeney noted a worst-case situation often referred to as hard censorship, where “nodes would be forced by regulation to basically discard any blocks with any of these transactions in them.”

“That would mean no matter how long you waited, no matter how much you paid, you would never get to a point where those sanctioned transactions would get included in the blockchain,” he explained.

He also pointed out that even in the event of soft censorship, where sanctioned transactions would eventually be validated, it could take hours and require a high priority fee, resulting in a sub-par user experience.

Related: MEV bot earns $1M but loses everything to a hacker an hour later

These findings are reinforced by Ethereum researcher Toni Wahrstätter, who published research on Sept. 28 suggesting that of the 19,436 blocks verified by the Flashbots Mev-Boost Relay, none included a Tornado cash transaction.

How many blocks from different MEV Boost Relays contain Tornado Cash transactions. Source: Toni Wahrstätter.

Censorship fears were prevalent before The Merge. Speaking to Cointelegraph, the lead investigator for crypto compliance and forensic firm Merkle Science, Coby Moran, suggested the prohibitive cost of becoming a validator could result in the consolidation of validator nodes to the bigger crypto firms — who are much more susceptible to being influenced by government sanctions.

Ethereum community splits over solutions for transaction censorship

Social slashing and even a user-activated soft fork have been suggested as possible responses to the threat of transaction censorship on Ethereum.

The Ethereum community has been divided over how to best respond to the threat of protocol-level transaction censorship in the wake of the United States government sanctions on Tornado Cash-linked addresses. 

Over the last week, Ethereum community members have proposed social slashing or even a user-activated soft fork (UASF) as possible responses to transaction-level censorship on Ethereum, with some calling it a “trap” that will do more harm than good and others stating its necessary to provide “credible neutrality and censorship resistance properties” on Ethereum.

The heated debate comes after Ethereum miner Ethermine elected not to process transactions from the now U.S. sanctioned Ethereum-based privacy tool Tornado Cash, which has prompted members of the Ethereum community to worry about what would happen if other centralized validators did the same.

The Ethereum community is also debating the effectiveness of social slashing to combat censorship on the Ethereum network, as the strategy could lead to a chain split with some validators processing transactions on the censorship-less chain and the others validating only the OFAC-compliant chain.

Social slashing is the process whereby validators have a percentage of their stake slashed if they don’t correctly validate the incoming transactions or otherwise act dishonestly.

This may become a significant issue if regulators require major centralized staking services like Coinbase and other major centralized pools, which together stake more than 50% of Ether (ETH) in the Ethereum Beacon 2.0 chain to only validate OFAC-compliant chains.

Founder of Cyber Capital Justin Bons argues that slashing “is a trap” that “represents a greater risk than the OFAC regulation” and will not be a viable solution to tackle censorship at the protocol level.

In a 21-part Twitter thread on Monday, Bons said that social slashing exchanges may “deprive innocent users of their deposits,” which would “violate their property rights.”

Bons also said that too many validators complying with law enforcement on Ethereum would “lead to a chain split,” at the point at which “censors start ignoring or do not attest blocks that contain OFAC violating TXs.”

Founder of Ethereum podcast The Daily Gwei Anthony Sassano wrote on Twitter on Saturday that “collateral damage is inevitable in social slashing […] it’s worth it to protect Ethereum’s credible neutrality and censorship resistance properties.”

Meanwhile, Geth developer Marius Van Der Wijgen shared a similar sentiment stating that preserving censorship on the Ethereum network should be the Ethereum community’s highest priority:

“If we allow censorship of user transactions on the network, then we basically failed. This is *the* hill that I’m willing to die on.”

“If we start allowing users to be censored on Ethereum then this whole thing doesn’t make sense and I will be leaving the ecosystem. […] I think censorship resistance is the highest goal of Ethereum and of the blockchain space in general, so if we compromise on that, there’s not much else to do, in my opinion,” he added.

Related: Tornado Cash ban could spell disaster for other privacy protocols — Manta co-founder

Crypto researcher Eric Wall added that to date, censorship resistance has served as a core property on the Ethereum network and that while we’re seeing some censorship on the front end, “it’ll only get bad if censorship starts happening side Ethereum itself.”

The Tornado Cash sparked censorship debacle has plagued the Ethereum community for over a week now.