Treasury crackdown on Tornado Cash punishes honest crypto investors

The Treasury Department’s crackdown on Tornado Cash was intended to stop criminals. But many ordinary crypto investors with honest intentions are now at risk.

“Any US citizen will need to be very careful when transacting with Tornado Cash,” Ari Redbord, head of legal and government affairs at research firm TRM Labs, said in an interview. “Remember, sanctions are strict liability. Intention doesn’t matter.”

Tornado Cash is being used by some people as a legitimate way to protect their privacy in the still nascent crypto market. When a buyer pays for something using a crypto wallet, the recipient of the transfer has access to the buyer’s public crypto wallet, showing account details and history.

Using a crypto mixing service like Tornado Cash masks these details by anonymizing the funds and concealing the buyer’s identity.

“There’s a need for solutions that can help you cover your tracks, even when you’re not doing anything illegal,” said Tom Robinson, chief scientist at blockchain analytics firm Elliptic.

In blacklisting Tornado Cash on Thursday, the Treasury Department said it was pursuing criminals who have used the service to launder more than $7 billion worth of virtual currency since it launched in 2019.

While the purpose of these sanctions from the Treasury Department’s Office of Foreign Assets Control (OFAC) is to block a country like North Korea from converting illicit crypto funds into more usable traditional currencies to finance proliferation, the side effect on ordinary investors will be harsh, experts told CNBC.

In the past, OFAC has placed cryptocurrency wallet addresses on its “Specially Designated Nationals List.” The Treasury Department is now moving toward a smart contract address that allows people to maintain their personal privacy, according to Peter Van Valkenburgh, director of research at the Coin Center, a nonprofit cryptocurrency think tank.

“It’s fundamentally different because now you’re not targeting a specific individual who is a known terrorist or a member of an enemy state,” Van Valkenburgh said. “You are targeting a piece of software that exists in a peer-to-peer network on the Internet.”

OFAC is somewhat of a nuclear option when it comes to financial oversight, according to Van Valkenburgh. He said it was more often used to identify a “supporter of terrorism or a leader in an enemy state”.

Jake Czerwinski, head of policy at the Blockchain Association, said this action marks a departure from precedent for the US Treasury Department, which for years has “carefully distinguished bad actors from neutral instruments” and “the technologies they (plus everyone else in the world) can use.”

Elliptic says there is also a difference between the Treasury data and its own calculations. Elliptic found that at least $1.5 billion in the proceeds of crimes such as ransomware, hacks and fraud were laundered through Tornado Cash, and says the $7 billion figure from the government refers to the total value of crypto assets that were sent via Tornado Cash.

The consequences are already obvious. Circle, the firm behind the US dollar-pegged stablecoin USDC, has reportedly frozen about $75,000 in USDC that were linked to Tornado, according to Dune, a crypto data aggregator.

Crypto exchange Coinbase will also have to block its customers from sending funds to Tornado Cash, given new ground rules from the Treasury Department.

Redboard says that crypto holders will eventually find a way to protect their identities.

“While today’s determination will affect US persons conducting legitimate transactions, they will likely find other avenues,” he said.

But the problem for crypto users looking for an alternative mixing service is that no one else has the scale of Tornado Cash, making it difficult to ensure that their identity is protected.

“If no one is using them, then it’s very easy to break through the mix and trace through them,” Robinson said. “You need a large amount of liquidity to be effective as a mixer, and it takes time to get that liquidity together and start that leverage,” Robinson said.

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