Tornado Cash Sanctions: What Crypto Investors Need to Know

In August 2022, the US Department of Treasury’s Office of Foreign Assets Control – also known as OFAC – sanctioned Tornado Cash, a cryptocurrency mixer that mixes funds together to make their sources harder to trace. Virtual currency mixing services can be used to launder stolen funds, and the US Treasury Department says Tornado Cash has reportedly processed over $500 million from multiple online hacks and robberies. The sanctions stipulate the following:

• Any assets currently held in Tornado Cash are frozen.

• Transactions to or from Tornado Cash are prohibited.

• The mixer’s code itself is forbidden (although it is essentially impossible to turn off the technology).

But while the sanctions were intended to target money laundering, some crypto enthusiasts feel that OFAC is overstepping its authority by sanctioning a digital asset rather than a person or organization. Critics of the sanctions are concerned about their implications for crypto users’ privacy and potential future shutdowns. In September, six people challenged these sanctions by filing a lawsuit, funded by the crypto exchange Coinbase, against the US Treasury Department.

Here’s what you should know about cryptocurrency mixers and what these government sanctions could mean for your future investments.

Cryptocurrency mixers, also known as tumblers or blenders, are designed to create actions on the blockchain more private by blending data from separate transactions. This prevents anyone from being able to trace where a particular asset came from, making transactions essentially anonymous.

Blending services charge a fee, usually between 0.25% and 3% of the amount sent through the blender. Although they may be legal if properly registered, mixers have made headlines for their use in money laundering and other cybercrimes.

Tornado Cash, for example, is one of the first decentralized applications on the Ethereum blockchain to offer private transactions and has reportedly “mixed” millions in stolen funds from several online robberies. One of the biggest heists that moved funds through the mixer was led by a state-sponsored hacking group from the Democratic People’s Republic of Korea sanctioned by the US Treasury Department in 2019.

According to a July 2022 report from blockchain analytics firm Chainalysis, mixer usage is at an all-time high, with 23% of funds sent to mixers from addresses linked to illegal activity.

What are sanctions and how are they enforced?

OFAC enforces economic sanctions – penalties that act as a deterrent to prohibited activities – against certain countries, individuals and business entities. The recent sanction against Tornado Cash is list-based, which requires the assets in the entity’s possession to be blocked and prohibits transactions with any associated actors.

OFAC has specific guidelines for sanctions against virtual currencies. Specifically, anyone holding a blocked cryptocurrency must report the asset to OFAC within 10 business days of the currency being blocked and deny others access to it (so no sale or trade). If you want to withdraw money, you must apply for special permission from OFAC.

As for Tornado Cash, as of August 8, 2022, US users are no longer allowed to send assets through the mixer – or retrieve funds stuck on the platform – without special permission from the US Treasury Department. OFAC noted that it would look positive applications from users want to withdraw their money.

How have crypto issuers and platforms responded to the sanctions?

• Pursuant to government sanction, Circle, issuers of USDC — a stablecoin pegged to the US dollar — froze over $75,000 of assets on the platform.

• The developers of Tether (USDT)another US dollar-based stablecoin, issued a public statement that they would not freeze all accounts associated with Tornado Cash, and would await an official, direct request from OFAC.

• Exchange platform Coin base is funding a lawsuit against the US Treasury Department over the sanctions, arguing that the Treasury Department overstepped its authority by blocking the software rather than just individual actors.

I don’t use Tornado Cash. Can this affect me?

For the majority of users, sanctions at this level will not affect their investments, but it does suggest that other crypto platforms used for money laundering may be shut down.

Currently, decentralized finance, or DeFi, apps like Mixers work more like the Wild West than Wall Street. They are meant to operate without intermediaries, but a lack of internal regulation can expose such platforms to abuse and potentially make them a target for government regulation or penalties.

Because Tornado Cash operates on the Ethereum blockchain, these events also have the potential to affect Ethereum as a whole. If the government told Ethereum validators to block blacklisted Ethereum addresses, for example, and a majority of validators complied, it would effectively make Ethereum more regulated. So far, the government has not made this request, and it is unclear whether a majority of validators would comply if it did.

How do I ensure that my crypto assets are not affected by sanctions?

“Make sure the products you invest in are from approved providers that comply with regulations,” says Katherine Dowling, Chief Compliance Officer at Bitwise Asset Management.

It can be tempting to use services that promise high returns or total privacy, but these platforms are not without risk. In the decentralized environment of cryptocurrency, it is especially important to invest in products with a clean track record. Penalties for violating OFAC sanctions can range from a warning letter to a substantial fine or even a criminal investigation.

However, it is impossible to predict whether a service will be used for illegal means. You also don’t always have control over sanction compliance: The day after Tornado Cash was sanctioned, an anonymous user sent small transactions from the mixer to high-profile Ethereum accounts, all of which were unable to block the transfers.

OFAC said it is aware of this practice, known as dusting, and will not prioritize enforcement against such recipients. However, if you are the recipient, you should decline or block the transaction within submit a report to OFAC within 10 working days.

What does this mean for crypto?

When Tornado Cash was sanctioned, authorities took control of all its addresses and froze their associated assets, which could set a standard for future government crackdowns on crypto.

“We’re going to continue to see points of tension between privacy and national security interests,” Dowling says. “But we’re going to have to make better instruments to deal with breaches.”

Until better tools exist to regulate products like Tornado Cash, government security measures intended to target illegal activity may also affect innocent users of these products.