A reflective analysis by Pauline Demchuk, Founder of TradeSanta.com, on the regulation trajectory in the crypto industry.
What happened with Tornado Cash
In August, the U.S. Department of Treasury imposed sanctions on the Tornado Cash blockchain platform. The statement claimed that the platform had laundered more than $7 billion worth of cryptocurrencies since its launch in 2019.
Tornado Cash is an open-source online crypto mixer that runs on the Ethereum network. It allows anonymous cryptocurrency transfers by breaking transactions into numerous small parts and mixing them together. It has been stated that since the project’s launch, nearly 100,000 transactions have taken place with an estimated value of $4 billion.
The source for the final figure of $7 billion remains unknown and hasn’t been revealed by the department.
The regulator’s sanctions against Tornado Cash induced an expected panic in the market, prompting clients to withdraw their funds. As a result, the rate of the TORN token collapsed by more than 50%.
The American authorities not only shut down all Tornado Cash property in the country but deprived U.S. residents of making transactions without special permission.
On the 12th of August, the Dutch agency of the Fiscal Information and Investigation Service (FIOD) detained the developer of the crypto mixer – Alexey Pertsev. He was based in Amsterdam at that time.
A criminal case was initiated against Tornado Cash, indicating that Pertsev was suspected of “involvement in concealing criminal financial flows and facilitating money laundering.” Although he was never formally or publically charged, the court decided to hold him in detention for up to 3 months.
How community reacted
The unexpected and instant measures against Alexey Pertsev provoked high levels of unrest within the crypto community, raising a debate about whether a developer is legally responsible for the outcome of the technology he created.
In support of Pertsev, the community stated that programmers who wrote the code for a cryptocurrency mixer used by other people for illegal acts should not be in jail for their offenses.
Many IT specialists create and develop open-source software in crypto projects these days. The current precedent affects them all, for if they can’t really trust the industry, how safe is their future?
Lee Reiners, Policy Director at the Duke Financial Economics Center: “Many within the crypto community believe the Tornado Cash sanctions and the arrest of Mr. Pertsev will hinder the development of decentralized finance applications and other open-source software applications. Crypto proponents argue this is a massive overreach and unjustifiably targets programmers who do not personally engage in illegal activity but build tools that bad actors may use. They wonder, where do you draw the line, considering that all financial applications and firms, including banks, are used by people engaging in illegal activity.
Omar Sarieddine, CEO of Three Thirty3, crypto investor: “Tornado Cash was essentially a smart contract made to create privacy for users. One could deposit crypto into a pool, which will come out on the other end, untraceable and with no link to your primary wallet address. For ideal users, this sounded like the solution to their privacy issues. However, this quickly became lucrative for financial criminals to launder illegal funds since there was no way to trace back the funds once they had gone into the “tornado” pool. It was inevitable for Tornado Cash to be sanctioned by the US since it was lacking regulation.”
What are the reasons
Undoubtedly, we can now observe that regulators have taken a course in tightening control over the market for DeFi and other digital services. There are two significant reasons for that:
1) The industry being in a “gray zone” hinders its development and mass adoption, causing problems for ideal users.
Omar Sarieddine: “Since blockchain solutions are still in their very early stages, what needs to be done is establish a balance between regulation and privacy where the concerned authorities will have access to investigate illegal funds where necessary, and at the same time maintain a decent level of privacy for ideal users. It is only a matter of time until the challenges of blockchain, including regulation and scalability, will be addressed and mass adoption kicks in.”
2) Authorities (except the Chinese, who prefer to ban everything related to cryptocurrencies) have not developed a unified behavior algorithm, selectively applying sanctions to particular projects.
Lee Reiners: “If the Treasury Department has evidence that any crypto protocol is being used to bypass U.S. sanctions or launder criminal proceeds, I fully expect they will continue to take action. Historically, OFAC (Office of Foreign Assets Control) was a little-known agency that didn’t draw much attention from the media or members of Congress. But since the Tornado Cash sanctions, you’ve seen Republican Congressman Tom Emmer send a public letter to OFAC demanding answers to several questions about sanctioning open source software. You’ve also seen crypto trade groups, like Coin Center, threaten to sue OFAC for exceeding its statutory authority. This is a level of scrutiny OFAC has previously not faced.”
What will happen next with crypto regulations
Omar Sarieddine: “History repeats itself, we all remember the internet dial-up connection and we have seen how far we have come with mobile applications. We are entering a new era of the internet, which will revolutionize how people and businesses process transactions.”
Lee Reiners: “Anytime someone gets arrested, people take notice. These actions demonstrate that it is not a reasonable defense to claim that a protocol is decentralized. Therefore, anyone who develops a cryptocurrency or DeFi app used for illegal activity may be held legally liable, even if illicit conduct is not the principal use case.”
Establishing regulations is an inevitable stage in the development of any market. It has advantages in terms of having clear and accessible rules for all participants, despite their background and field of activity.
It will also simplify the route for big players to enter the crypto industry from more traditional markets. However, all regulations must be introduced with common sense and respect to market and community feedback.
In the case of Alexei Pertsev, it is not entirely correct to share any comments until the specific charges are brought forward. However, the precedent itself for the arrest of the developer of an open source solution is a major wake-up call.
To conclude, the main point in this discussion will always be the same: one must separate product development and its possible illegal use. Rules must be introduced but with an account of the ethical and moral grounds.
The latest actions in the Tornado Cash case became a lawsuit against the U.S. Treasury funded by Coinbase. According to the statement of Brian Armstrong, CEO and cofounder, the allegations against open-source technology cause harm to the innocent people, denying their rights to financial privacy.
He also believes that the Treasury exceeded its authority, given by Congress, by sanctioning a technology.
Brian Armstrong: “We will fully comply with the law while we await the court’s decision. But we’re hopeful that these sanctions will be reversed, allowing innocent crypto users to regain access to their funds and making it possible for anyone to use privacy tools to protect themselves.”
Overall, the Tornado Cash case revealed the following issues that caused an immediate reaction from the crypto community and determined what impact this could have on the development of an innovative industry:
- The accusation of open-source developers discourages their creativity and puts at risk their will to push the industry forward;
- Unreasonable regulations can lead to a containment of the crypto industry due to the high degree of state control;
- Sanctions against technology helps to fight criminals but simultaneously it harms innocent people, and threatens the future of decentralized finance (DeFi) and web3 specifically.
List of high-profile cases:
- Pavel Durov’s project: a global ecosystem TON and cryptocurrency Gram. The project attracted $1.7 billion investments from public figures, including Roman Abramovich and Jared Leto. However, it was forced to shut down after the U.S. Securities and Exchange Commission (SEC), and then the court, recognized Gram tokens as securities. The court banned the transfer of tokens to TON investors.
- In 2020, the SEC sued a cryptocurrency platform Ripple. According to the department, the project was engaged in an unregistered sale of securities under the guise of XRP tokens in the amount of $1.3 billion. Later, the regulator focused its attention on the actions of senior-level executives of the company. The process is still going, and attracts a lot of attention from the community.
- The case against the Bitcoin Fog service and the arrest of Roman Sterligov in April 2021. Roman was one of the first creators of crypto mixers. According to the U.S. authorities, he was involved in the laundering of more than 1.2 million BTC in the amount of $336 million using the Bitcoin Fog service.
- In spring, Blender.io, a bitcoin mixer, fell under the sanctions of the U.S. Department of Treasury. The accusations against the service coincide with those later brought against Tornado Cash – money laundering and cooperation with the hacker group Lazarus Group for these purposes.