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Crypto think tank prepares for challenge to Treasury Tornado Cash sanction

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Emerging Technology, Government Oversight, Nonbank Financial
Friday, August 19, 2022

Crypto think tank Coin Center is preparing a challenge to the Treasury Department’s sanctions on crypto mixer Tornado Cash. This is the second major crypto mixer that has been sanctioned by the Treasury Department, following the May 6 sanction of Blender.io.

On Aug. 8, the Department of Treasury’s Office of Foreign Assets Control (OFAC) sanctioned crypto mixer Tornado Cash. Treasury alleged in their sanctions that Tornado Cash has been used to launder more than $7 billion worth of crypto assets since its creation in 2019, including $455 million stolen by the Lazarus Group, a Democratic People’s Republic of Korea state-sponsored hacking group that was also sanctioned by the U.S. in 2019.

“Despite public assurances otherwise, Tornado Cash has repeatedly failed to impose effective controls designed to stop it from laundering funds for malicious cyber actors on a regular basis and without basic measures to address its risks,” Under Secretary of the Treasury for Terrorism and Financial Intelligence Brian Nelson said in a press release. “Treasury will continue to aggressively pursue actions against mixers that launder virtual currency for criminals and those who assist them.”

Treasury’s sanctions require all property and interests in property held by Tornado Cash in the U.S. or in the possession or control of U.S. persons be blocked and reported to OFAC. The sanction also prohibits all transactions by U.S. persons or within the U.S. that involve any property or interests in property of blocked persons or entities unless authorized by OFAC.

The inherit anonymity of Tornado Cash makes the efficacy of these sanctions questionable. The service was designed to operate without centralized control. Tornado Cash’s developers have made open source its entire user interface, allowing anyone to weigh in on the code or the mixer’s design.

Tornado Cash co-founder Roman Semenov previously told Bloomberg News that it would be “technically impossible” for sanctions to be applied to Tornado Cash because of its decentralized protocols.

Following the sanctions announcement, Coin Center, a leading crypto-focused policy think tank, published a blog post indicating that it was preparing a challenge to the Tornado Cash sanctions.

The sanctions targeted the smart contract that runs the decentralized finance (DeFi) mixer as well as the crypto wallets associated with the coders behind Tornado Cash. In the Coin Center blog post, the think tank questioned the capability of sanctioning a smart contract. Coin Center argues that a smart contract is not capable of challenging a sanction from OFAC in court. “By treating autonomous code as a ‘person’ OFAC exceeds its statutory authority,” wrote Jerry Brito, Coin Center's executive director, and Peter Van Valkenburgh, its director of research.

OFAC’s authority is derived from the International Emergency Economic Powers Act (IEEPA) and the National Emergencies Act (NEA) which empowers the president to declare national emergencies and utilize the IEEPA to block any “transactions involving any property in which any foreign country or a national thereof has any interest” by any person subject to the jurisdiction of the United States.

In this case, the relevant emergency was declared in an executive order by President Barack Obama in 2015. The emergency declaration was designed to address “the increasing prevalence and severity of malicious cyber-enabled activities originating from, or directed by persons located, in whole or in substantial part, outside the United States.” That order, citing the statutory authority described in IEEPA, is what empowers the Treasury to block “property and interests in property” related to persons engaged in cyberattacks.

“The power afforded the president by IEEPA is broadly drafted, but it is nonetheless only a power to block property [emphasis added],” the blog post read. “The Tornado Cash Entity does not have a property interest in the Tornado Cash Application. It has no legal right to control that application, and, perhaps more importantly, it has no physical ability to control that application.”

Coin Center asserts that the Tornado Cash application is not even property “in any reasonable sense of the word.” The application is non-proprietary software residing simultaneously on the computers of every person around the world running the Ethereum open-source client. Coin Center compares this to the notion that every Phillips-head screwdriver in every American home is the property of Henry F. Phillips, its inventor.

Coin Center further argues that “if the Tornado Cash Application is not ‘property in which some foreign country or national has an interest,’ then the Tornado Cash Application cannot properly be added to the SDN List or blocked under the specific powers granted by Congress to the president in IEEPA.”

Within its blog post, Coin Center makes efforts to address the applicability of IEEPA to intellectual property, a designation which some may say that the Tornado Cash application fall under.

“Sanctions involving intellectual property typically deal with whether proprietary tools can continue to be licensed from sanctioned individuals, or whether one could buy trade secrets from a corporation in an enemy state,” the blog post read. “In the present case, the sanction is accomplishing something very different; it’s saying Americans can’t even make use of intellectual property in which the authors have no economic interest.”

Coin Center also suggested these sanctions against Tornado Cash are an infringement upon the Fifth Amendment rights of the applications users. Because of these sanctions, some American users have seen their crypto-assets locked in the application with no way to access them.

“These Americans with locked funds have not (yet) committed any crime by virtue of using Tornado Cash in the past, because sanctions are always forward looking and backward application would be an unconstitutional ex post facto action,” Coin Center claims. “These Americans are the only people who have the physical capability to remove funds from that address because they are the only persons who know the cryptographic data demanded by the Tornado Cash application to create a valid withdrawal transaction. Nonetheless, these Americans cannot make that transaction without, ostensibly, violating OFAC sanctions. This, therefore, is a deprivation of property as well as liberty.”

Not everyone in the crypto community is opposed to the Treasury’s decision to place sanctions on crypto mixers like Blender and Tornado Cash.

“I look at [the sanctions] as a way to prevent some of those incentives for people to commit these types of crimes against enterprises,” said Bryan Daugherty, a certified cryptocurrency investigator and the public policy director at the Bitcoin Association, in a report from The Hill.

Daugherty added that crypto mixers are often used by criminal groups to obfuscate illicit funds and doesn’t see why non-criminal users would want to run the risk of using the same platform.

By using mixers, “you will run the risk of contaminating your legally-gained coins with somebody else’s illegally-gained coins,” Daugherty said.

A recent report from Chainalysis, a blockchain data firm, found that the use of crypto mixers reached an all-time high in 2022, with state-sponsored actors and cybercriminals making up a large portion of users. Illicit addresses accounted for 23 percent of funds sent to mixers, up from 12 percent in 2021, the report found.  

“Overall, if we label cybercriminal organizations with known nation state affiliations, we can see that these groups make up a significant and growing share of all illicit cryptocurrency sent to mixers,” the report said.

Coin Center concluded its blog post that it “will begin exploring with counsel a court challenge to this action.” It is unclear if a court will entertain an argument of standing by the think tank on behalf of Tornado Cash and/or its law-abiding users.

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