Amid Tornado Cash Sanctions, Decentralization Of Crypto Remains An Enigma

When the movie ‘I, Robot’ highlighted the dilemma of attempting to program ethics into robots through the ‘three laws’, the dystopian future of machines rebelling against humans still remains a Hollywood production of fiction. However, between Artificial Intelligence and now programmable smart contracts on a blockchain, it appears the future of how we apply our morals and rule of law in a world of code and machines suddenly is here.

Despite the popularity of Terminator, I, Robot, or any other science fiction movie that takes a stab at what could happen to the human race, we still find ourselves woefully unprepared for a dilemma of our rights to privacy in a world of digital money versus the potential for future cataclysmic events that could be funded through these same ‘privacy-enhancing’ tools.

However one might imagine the future, the present puts us to the test, as a smart contract on the Ether
ETH
eum blockchain called Tornado Cash finds itself on a sanctions list, alongside other individuals and businesses. How the U.S. Government managed to further complicate the issues of a complex space is quite impressive amid the creation of NFTs, DAOs and DeFi. The problem that exists and the long road ahead involves attempting to develop a paradigm for how regulation might occur in a decentralized landscape.

Ari Redbord, Head of Legal and Government Affairs at TRM Labs interviewed with me to help dissect the issue. Redbord affirmed the complexity of what we saw unravel last week. “And I think Tornado Cash is particularly complicated because it really is OFAC first action against a cryptocurrency business this size but also be a cryptocurrency business that touches this much legitimate activity. Right?” said Redbord. Having previously served as a Senior Advisor to the Under Secretary for Terrorism and Financial Intelligence at the U.S. Department of the Treasury, further pointed out that, “…regulators like Treasury are saying, Look, we, obviously are not banning the technology, but what we’re doing here saying that if you are a service that is allowing North Korea and other cyber criminal elements from laundering billions of dollars in stolen proceeds, then you’re going to be a target of sanctions.”

I also interviewed Kathy Kraninger, Vice President of Regulatory Affairs at Solidus Labs and former Director of the Consumer Financial Protection Bureau. Kraninger broke down the paradigm from the perspective of the sanctions list that OFAC keeps. “The sanctions list is an identity-based concept. You have a person in the real world that you are trying to block from accessing the illicit funds that they have gained through terrible means,” said Kraninger.

Beyond the immediate threat of how do we ensure a ‘tool’ does not cause a national security crisis, Kraninger highlighted the issues around consumer protection for anyone who may have their wallet ‘dusted’, or sent cryptocurrency from Tornado Cash without requesting it. “The imperative to stop the illegal activity is there but the ability again for people who are not Jimmy Fallon or Brian Armstrong to prove the negative that they were not at all involved where their wallets were dusted…raises all kinds of challenging implications in this space,” stated Kraninger.

Kraninger highlighted the complications associated with cryptocurrency and sanctions enforcement, in that, “…people clearly who are caught in the crossfire of this who shouldn’t be at all associated with sanctions lists and so trying to figure out how to really segregate that out in a smart way is something they need to communicate about too.”

In the words of Winston Churchill the, “…riddle, wrapped in a mystery, inside an enigma,” of Tornado Cash clearly has sent shock waves through the ecosystem as to how to interpret what behavior for computer scientists could run them afoul of the law. Redbord declared, “Is it complicated by the sort of decentralized nature by the fact that this is software, not necessarily an entity or an individual? Absolutely.” Kraninger said, “It does become challenging when you don’t have a real-world identity or a real-world intermediary in a system that you can actually put your hands on…software and protocols and wallets that you can create on your own with software.”

Redbord described more obvious cases where sanctions are applied such as he describes it, “darknet market advertising, such as mixing services, like Helix and Bitcoin
BTC
fog, which were literally criminal enterprises that were advertising on the dark web, to launder funds in crypto.”

So, while many fear that we might experience further signals from regulators that may create a chilling event for creativity and exploration, Redbord noted some light that may be at the end of the tunnel in all of this. “I think that one one sort of overall theme maybe is that there is a technology solution to all of this. It doesn’t have to result in over-regulation. Because look, if you don’t trust an exchange, because you believe it’s going to be hacked, or you’re not going to put your funds into a defi protocol, because you believe that they could be stolen, right or you’re not going to put your funds into crypto. Then none of this works, right? This new financial system that we’re building together, only works if there’s a trust layer, and I believe that we’re sort of helping build that trust layer by providing tools to stop illicit actors from taking advantage of it.”

Kraninger described the work at Solidus Labs focused on, “Understanding that ecosystem and building market surveillance solutions into a full compliance suite of off-chain capabilities for fiat and crypto and integrating with blockchain analytic companies.” For Redbord and his role at TRM, he stated, “…from a TRM standpoint, look, our job is to ensure that our clients have the tools that they need to comply with sanctions…We want to ensure that our clients have the tools necessary to mitigate risk of exposure to tornado cash going forward.”

Hopefully companies like Solidus Labs and TRM Labs can help create a program of compliance that will satisfy authorities and at the same time allow for the developers and programmers in cryptocurrency to still have the sense of freedom that is critical for developing these decentralized offerings. Meanwhile, it should be a priority for policymakers to consider and perhaps rethink what an effective and fair sanctions regime looks like in a landscape of digital assets.

Disclosure: I have no vested interest in Solidus Labs or TRM Labs.