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The unusual action taken by the U.S. government to endorse a smart contract on Ethereum is still having negative effects.
The Tornado Cash cryptocurrency mixing business was completely outlawed on Monday by the US Treasury Department. The open-source protocol is inaccessible to all American "persons," a decision that is expected to have broad ramifications for the crypto community.
38 addresses with connections to Tornado in their transaction history were instantly banned by Circle, one of the issuing organizations behind the USDC stablecoin, as a result of the sanction. According to anecdotal reports, other platforms and businesses may also be enforcing bans.
By making dealing with Tornado Cash illegal, Treasury's Office of Foreign Assets Control has created a huge hole in the heart of the cryptocurrency industry. On Ethereum, the most popular blockchain, it is now more difficult to maintain transactional privacy, and platforms and individuals must now assess their vulnerability and take precautions against any regulatory action.
"It's too soon to make any assumptions here. This is uncharted ground. Neeraj Agrawal, director of communications at Coin Center, stated via email that "we are still seeing what is even doable." The second-order impacts of the ban are still being felt, and it is still unclear if regulators will be able to impose such a broad restriction or whether cryptocurrency will be able to abide by it.
With the help of the open-source project Tornado Cash, users can hide their transaction histories from the general public. According to the U.S. authorities, this business has been used since 2019 to launder more than $7 billion in illicit proceeds, including by North Korean hackers.
The government has enacted a broad prohibition on the protocol rather than pursuing the aforementioned hackers or other clearly identifiable criminal actors. An analytics business called Elliptic claimed to have discovered $1.5 billion in illegal cash obtained through hacking, fraud, or ransomware.
The use of cryptocurrency mixers allegedly reached an all-time monthly high in April of this year, when $51.8 million was allegedly laundered across various platforms, according to a research from data firm Chainalysis.
Jerry Brito, executive director of the Coin Center, and Peter Van Valkenburgh, research director, wrote earlier this week that "it is not any specific bad actor who is being sanctioned, but rather all Americans who may wish to use this automated tool in order to protect their own privacy while transacting online who are having their liberty curtailed without the benefit of any due process."
Another essential element of the Ethereum "money stack" is Tornado. Although it wasn't the only method used to anonymize transactions on the blockchain, it was arguably the most popular. The vast majority of ETH-compatible applications probably have some exposure to the mixing service. (Co-creator of Ethereum Vitalik Buterin revealed he used the platform before making a donation to Ukraine this year.)
Furthermore, despite the fact that Tornado has been given a criminal categorization, the government cannot really block the application. It also won't prevent users from interacting with the code or moving it to an unapproved location.
Tuesday, a jokester made fun of the issue by transferring modest sums of ETH to prominent cryptocurrency investors, such as Jimmy Fallon and Coinbase CEO Brian Armstrong, from a Tornado wallet, illustrating the difficulty the government will have in implementing its penalties. Cryptocurrency transactions are irrevocable, and people who receive them may now be held responsible for connecting with a prohibited address.
According to Tor Bair, the creator of the privacy-focused Secret Network, "Protocols purely addressing for transactional privacy face a tough path forward, as their narrow focus makes them a target for regulators that primarily seek to curb illicit financial activity."
Protocols that haven't been actively considering these scenarios since Day 1 are in for a rude awakening. Without taking into account every risk and tradeoff, you cannot create any trustworthy or long-lasting privacy solution, the expert continued.
Making plans for a backup in case MakerDAO is "nuked" by authorities due to its exposure to Tornado is a clear hint of how the Tornado ban may affect the entire sector. The DAI stablecoin, a platform that enables users to mint U.S. dollar proxies by making crypto deposits, is algorithmically issued by Maker.
Rune Christensen, the inventor of Maker, started outlining an emergency plan to shut down the "core" contracts that enable the stablecoin, which seems to be gaining a lot of traction. DAI's exposure to the USDC stablecoin, which makes up more over a third of its collateralized deposits at the moment, is particularly concerning. Maker currently holds $3.56 billion USDC.
Making moves in this area is important because Maker is now the largest decentralized finance (DeFi) system by value. DeFi platforms are probably attempting to lessen their exposure to USDC and other problematic assets, which are sitting on their balance sheets like ticking time bombs, across the board. It could be expensive and time consuming to unravel this, but it is vital.
Circle advertises its U.S. dollar-pegged stablecoin as the most trustworthy and compliant on the market. Prior to the Tornado sanction, Circle had already banned up to 50 addresses in order to abide by legal requirements. As a result, the DeFi industry has greatly integrated USDC.
The answer is not to criticize Circle for adhering to the rules, even if those regulations are overbroad and incorrect about how cryptography operates. However, protocols ought to take OG Erik Voorhees' advice and wean themselves off of USDC in favor of censorship-resistant substitutes.
Although it is unclear how events will unfold over the coming days, weeks, and months, it is becoming evident that the needs of crypto and the requirements of the modern governments of the twenty-first century are incompatible. That is intentional.
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