Cryptomixers are making headlines, but what are they?

With crypto mixers, especially Tornado Cash, increasingly under regulatory scrutiny, facing sanctions and generally attracting the wrong kind of attention, it seems like an opportune time to take an objective look at these services. Namely, what do cryptomixers do, why would individuals or institutions seek to use these services, and what are the potential legal and regulatory implications of doing so? As with most things in the cryptoasset space, investors and users of these products and services should conduct due diligence on the service itself, who else is using said service, and examples of how past issues have been resolved.

In other words, this is a good example of why it is important to always carry out robust due diligence.

For the purpose of this talk, the focus will be on non-custodial cryptomixers, which can make it more difficult for regulators to take action against bad actors, but also reduce risk for users of these services. Due to the fact that crypto-assets are never held by a trusted third party or other entity, and instead are completely managed by smart contracts and the underlying blockchain, the risk of theft by unethical actors is reduced.

Let’s take a look at some key questions and considerations that both investors and regulators should keep in mind when discussing, considering or potentially using cryptomixers.

What is a cryptomixer? Just as the name describes, a crypto mixer is a service (which can be centralized or decentralized) that increases the anonymity of certain crypto transactions. Users deposit crypto into a smart contract designed to perform the compounding transaction from a single address. After a predetermined period of time, users can withdraw the previously deposited tokens from another address. The specifics of the mixing process are unique to each cryptomixer, and users can verify/verify the crypto that was deposited via a variety of cryptographic techniques that – again – vary from protocol to protocol.

Why would investors use such a service? It is also worth remembering that the origins of blockchain and crypto-assets – however far it has evolved since – were heavily influenced by libertarian ideas. These include, but are not limited to, a desire for increased privacy and anonymity regarding personal transactions, and a much reduced role for governments, regulators and (specifically for crypto) incumbent financial institutions. Crypto mixers increase the anonymity and privacy of crypto transactions, which can benefit individuals seeking privacy, or users who want to circumvent restrictions that may exist in some jurisdictions, such as nations that have – effectively – banned crypto transactions altogether.

What is the risk? As has recently been demonstrated, the view governments and regulators have on cryptomixers is mixed at best (no pun intended). Allegations of the use of mixers to facilitate money laundering and criminal activity of all kinds have been leveled against the entire sector. Sanctions have been implemented against several of the highest-profile providers in the area, with the Office of Foreign Asset Control (OFAC) designating a smart contract as a Specially Designated National, a label usually reserved for nation states. As crypto mixers continue to gain higher profiles, this will in turn lead to more regulators taking a long look at the operation of these protocols, as well as the investors who exploit them.

From an advisory perspective, there are certainly use cases and situations where a crypto mixer can be used for perfectly legitimate purposes. It is also worth pointing out that traditional financial services firms have routinely facilitated illegal payments, or laundered money obtained from illegal sources. That being said, it seems safe to say that going forward there will be many more questions that users, investors and institutions related to cryptomixers will have to answer. Clients of all sizes should keep this in mind before allocating assets to mixers, or entering into business with counterparties that do.

Like everything in the blockchain and cryptoasset space, cryptomixers have rapidly evolved, grown, and burst into the mainstream financial conversation at a breakneck pace. As regulators continue to catch up with the private sector, regulation and enforcement will always be more common. Crypto investors, developers, and the advisors to these entrepreneurs would do well to take note.