The Tornado Cash crackdown was just the first round

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Decrypt DeFi is Decrypt’s DeFi email newsletter. (drawing: Grant Kempster)

This week, the US government shook everyone up in crypto.

The Treasury Department has sanctioned crypto mixer Tornado Cash as well as several crypto wallet addresses associated with the service. This means that the protocol and its associated smart contracts are now blacklisted, making them illegal for Americans.

Tornado is a privacy tool that allows users to hide where their funds are and where they go. Basically, this turns the transparency of blockchain technology into a black box, hiding your crypto activity.

The Treasury backed the move by saying the Lazarus Group, a hacker group with ties to North Korea, used the service to launder stolen crypto (including $96 million the group recovered in the recent attack on the Harmony Bridge).

In total, the Treasury said the service “has been used to launder more than $7 billion in virtual currency since its inception in 2019.” Technically, all that money wasn’t bleachedhowever, according to crypto detective firm Elliptic.

About $7.6 billion worth of crypto has indeed crossed Tornado, but only $1.5 billion of those funds were illegally obtained (and therefore laundered), Elliptic said in a report.

Chainalysis, another blockchain watchdog, also reported that nearly half of that $7.6 billion came from DeFi (none of which, according to Chainalysis, is necessarily illicit).

Source: Chain Analysis

With the privacy-centric service now blacklisted, the wider crypto community is angry.

Crypto advocacy group Coin Center argued that the sanctions don’t necessarily target a specific terrorist group or similar, “rather, it’s all Americans who want to use this automated tool to protect their own privacy when transacting.” online who have their freedom curtailed without the benefit of due process.

Even Ethereum co-founder Vitalik Buterin admitted that he used Tornado (before it was blacklisted) to donate to Ukraine.

Besides the perceived privacy breaches, the new sanctions have also had some interesting ripple effects within DeFi that we’re only just starting to see happening.

Decentralized derivatives exchange dYdX almost immediately banned addresses associated with Tornado Cash. The project even said its “long-used compliance providers” (likely serviced by Chainalysis or Elliptic) have erupted with a “sudden influx” of reported accounts.

But many of those accounts, dYdX admitted, had “never directly interacted with Tornado Cash.”

This is an embarrassing mistake, and also shows how much some crypto projects aim to be compliant, even “decentralized” efforts.

Meanwhile, from the more crypto-anarchist side of the industry that we’ve all come to love (and hate), there have been ingenious responses to Treasury sanctions.

Take, for example, the serial dusting of small amounts of ETH Tornado’d to tons of high profile celebrities.

As it stands, Jimmy Fallon might have technically broken sanctions laws simply because someone sent him that tainted ETH. No one can block these transactions either; they are truly unstoppable.

And thanks to Treasury actions, the world may soon learn just how powerful that can be – sanctions be damned.

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