Two years ago tomorrow, the U.S. Treasury’s Office of Foreign Assets Control (OFAC) sanctioned the Tornado Cash crypto mixer, which is used as a privacy mechanism for both legitimate and illicit purposes. The sanctions were imposed following allegations that it was used to launder $7 billion, including at least $455 million stolen on behalf of North Korea. In the crypto world, these sanctions were a hugely contentious issue. Today the New York Federal Reserve (NY Fed) published a staff paper exploring the impact of the Tornado Cash sanctions. The mixer is still in operation today. A key conclusion in the paper is that Ethereum’s censorship resistance is tenuous because most people complied with the sanctions.
This is based on tracking Ethereum block proposers and the builders responsible for selecting transactions for settlement. Many large builders cooperated with the sanctions. A couple of builders who did not comply with the sanctions were responsible for most of the ongoing Tornado Cash transactions. Towards the end of the sample period, a single builder was responsible for building most blocks that included Tornado Cash transactions.
“The withdrawal of other established builders from building non-cooperative blocks sheds light on the fragility of censorship-resistance of the Ethereum network,” the paper states.
However, there was little change in the behaviour of block proposers. While proposers rarely look at the content of blocks, the NY Fed noted that they could have blocked certain builders based on their cooperative or noncooperative behavior.
The researchers explored the motivations, perhaps expecting the fees for the Tornado Cash transactions to rise, but they dropped. Hence, the authors conclude the non-cooperative block builders are acting for philosophical reasons rather than monetary motives.
Privacy versus criminality
The paper briefly mentions that six Ethereum users took OFAC to court (and lost), but it doesn’t dwell on the controversy. Hence, what follows is not part of the paper.
Without taking additional steps, most public blockchain transactions are entirely transparent. If someone uses the same wallet for all activities, it’s easy to get a good picture of their actions. Even if they transfer money into a new wallet, that’s also visible. From a marketer perspective it’s a dream. For those that value privacy, it’s unappealing. Crypto mixers are an important tool for those that like privacy. OFAC’s sanctions impacted those people as well.
Maybe some of those people have something to hide, but most of them don’t. Just like some people prefer to close the curtains at night, others are comfortable leaving them open. Privacy should be a choice. The right to privacy is Article 12 in the Universal Declaration of Human Rights.
However, waiving privacy is a price everyone is expected to pay to help to combat crime. Those that are most impacted are often the people at the bottom of the chain who pay high transaction fees for remittances in part because of anti money laundering (AML) procedures. That’s despite the abject failure of AML procedures. A McKinsey report noted that suspicious transactions flagged by banks are up to 99% false positives.
While the NY Fed paper highlights that cryptocurrencies “are implicated at the nexus of cyber and financial crime,” Chainalysis figures show that currently illicit crypto transactions are around a third of one percent of all transactions. Crypto aside, illicit finance makes up 3%-5% of GDP globally. That’s despite years of spending tens of billions on AML and the associated privacy compromises.
From a regulator perspective, the ability of sanctions to impact the censorship resistance of permissionless blockchains is considered positive. For those that value privacy, not so much.
