Square Pegs and Round Holes: Tornado Cash, Anti-Money Laundering, and Crypto

On August 8th, the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) went after virtual currency “mixer” Tornado Cash.  Tornado Cash was sanctioned, and as the Treasury’s press release notes,

As a result of today’s action, all property and interests in property of the entity above, Tornado Cash, that is in the United States or in the possession or control of U.S. persons is blocked and must be reported to OFAC. In addition, any entities that are owned, directly or indirectly, 50 percent or more by one or more blocked persons are also blocked. All transactions by U.S. persons or within (or transiting) the United States that involve any property or interests in property of designated or otherwise blocked persons are prohibited unless authorized by a general or specific license issued by OFAC, or exempt. These prohibitions include the making of any contribution or provision of funds, goods, or services by, to, or for the benefit of any blocked person and the receipt of any contribution or provision of funds, goods, or services from any such person.

Before I get into the meat of this post, let me explain what a mixer is.  The idea of a mixing service is to literally mix “good” cryptocurrency with “bad” cryptocurrency so that no one knows if you have bad cryptocurrency.  Tornado Cash allegedly took in Ethereum (ETH) from people who just wanted to anonymize their transactions (which is not illegal) and from others who were criminals or state actors such as North Korea, mixed it all together, and it became very difficult (if not impossible) to tell good crypto from bad crypto.

What is the legal basis of Treasury’s sanctions? Anti-money laundering laws.  Let’s go back to the days of the mafia.  Assume you have $500 million of tainted cash you’d love to invest (and have turned into “good” cash).  In John Grisham’s The Firm the mafia used a tax law firm to money launder the funds in the Caribbean (with about 25% of each ‘shipment’ lost to bribes and corruption).  Today, moving such cash around to be legal is tougher than ever as most countries exchange information with each other.  The laws that prohibit this date from this time (and are part of the Bank Secrecy Act and the later Patriot Act).

That takes us to cryptocurrency. The Financial Crimes Enforcement Network (FINCEN) ruled that cryptocurrency is a type of currency and is subject to the anti-money laundering laws.  This means firms anywhere in the world who deal with Americans must have anti-money laundering law practices for cryptocurrency.  Similar laws exist in most of the world.

But isn’t cryptocurrency anonymous?  No, it’s pseudonymous.  The blockchain is permanent, so if you can figure out someone’s address you can trace people.

Not only was Tornado Cash sanctioned, a developer of the software was arrested in the Netherlands.  Now, I am not an attorney (and I am not in the Netherlands), but I was told by an individual who is familiar with the Netherlands’ anti-money laundering laws that they are similar to those of the US, only tougher.  But how can writing software (or ‘code’) be illegal?

I suspect the issue isn’t the writing of the software; rather, it’s allowing the software to be used and being active in the website allowing the mixing.  Let’s say I write software to allow Bitcoin to be mixed.  I post the software on an open-source forum.  That’s probably not illegal.  But what if I now actively market this product, don’t do anything to comply with anti-money laundering laws even though I don’t take any profits from the mixing: Have I committed a crime?  Almost certainly I have (probably multiple felonies).

That’s the problem cryptocurrency advocates face: the real world is intruding, and anti-money laundering laws are part of the real world.  Here, cryptocurrency is a square peg and the round holes are the anti-money laundering laws.  While I do see headlines stating, “Coin Center prepares legal challenge to Treasury’s Tornado Cash sanctions,” I highly doubt any such challenges will be successful.  FINCEN’s pronouncement that cryptocurrency is a currency for anti-money laundering law purposes seems reasonable (and almost certain to pass Chevron muster), and there’s nothing unconstitutional with the anti-money laundering laws.

But, Russ, won’t that will lead to cryptocurrency being centralized?  Won’t this just defeat the purpose of cryptocurrency and it will just become (more or less) another form of currency–just digital and online?  Yes, that’s the likely result.  This may not please the Libertarian cryptocurrency advocates but I don’t see anti-money laundering laws being overturned during my lifetime.   It appears the freewheeling age of cryptocurrency is ending sooner rather than later.


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