The Downside of Sanctioning Tornado Cash

We all remember the iconic scene at the start of the “Wizard of Oz.” There’s the terrifying sound of the tornado as it rampages across the land. All the while Dorothy Gale struggles to get home as she holds on to her dog for dear life. At a glance, it’s easy to see this tornado as a force of evil rather than just a neutral act of nature, or even as the start of a powerful chain of positive developments.

But suppose the tornado had never raged through Dorothy’s Kansas. The Wicked Witch of the East would be no worse for wear and would continue causing harm to honest folks in concert with her sister in the West.

The recent sanctions to stop Tornado Cash could have similar unintended consequences as removing the twister from the film. On the surface, they appear to be an honest attempt to stomp out evil, and yet upon closer inspection, they stand to do more harm than good.

Gets is a product manager for Espresso Systems, creators of the Configurable Asset Privacy protocol and team behind the Espresso layer 1 blockchain. Gets has spent the last five years building products and communities behind the scenes for privacy-oriented projects across crypto and Web3.

Last week, the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) sanctioned Tornado Cash, a privacy tool that has been running on the Ethereum blockchain for three years. The Tornado in this case is a smart-contract application that has drawn concern from the U.S. government for its alleged use in the laundering of hacked or stolen funds by the North Korean government. What makes this event so notable is that the OFAC has sanctioned the code running the Tornado Cash application rather than sanctioning individuals or entities using the tool for crime. The project has been deemed a force of evil.

That, however, may be an opportunity for the crypto industry to focus on advocacy for reasonable approaches to privacy and also to double down on privacy innovations that can protect users without putting users at risk of government backlash. Amid the chaos and fallout of the storm following the sanctions, we can start to discern some areas of opportunity for net-positive outcomes for the industry and for users of cryptocurrency products.

There are many uncertainties facing the industry: Tornado Cash is still up and running. Even on the day after the sanctions, it processed over $2 million worth of cryptocurrency transactions. The code itself cannot be stopped. While it remains to be seen whether the smart contract will stay in use and continue facilitating privacy for those who choose to violate the sanction, it is, practically speaking, impossible to shut down at a technological level.

One of the most notable problems has been trolls sending funds from Tornado Cash to random wallets. Since the sanctions were imposed, many withdrawals of 0.1 eth from Tornado Cash have been sent to well-known Ethereum accounts. If the receipt of goods from Tornado Cash is now prohibited, then the owners of these accounts are now, at least on paper, in violation of the new sanction. Even if they’re unlikely to get in trouble, they have to live with a Sword of Damocles over their heads. That risk has even briefly caused innocent users to be barred entry from decentralized applications such as dYdX.

The sanctions have created complexity and raised fears and questions for users of the product who were leveraging it for purely licit and even mundane purposes. Under the new sanctions, it isn’t clear yet what happens to a U.S. citizen who had a substantial amount of funds sitting in Tornado Cash. As of now, his funds are blocked and have to be reported to OFAC. There is no clear process for recovering those funds.

It would appear that recovering his funds would, right now, constitute a sanctions violation. At a minimum, there is no clarity. To many, the sanctions appear either to have been a heartless move, forsaking the privacy needs and financial integrity of innocent users, or to have been a thoughtless one.

It thus becomes clear why sanctions historically have largely been applied to entities involved in laundering money as opposed to the tools and technologies themselves. When applied to the tools, there are inevitably consequences for innocent users. Not only that, but sanctioning the tool, which is built on a decentralized platform run by nodes from all around the world, is arguably not even effective from an enforcement perspective, a notion demonstrated by the fact that Tornado Cash is still processing large volumes of funds.

Tornado Cash exists on the Ethereum blockchain as a smart contract. Ethereum in turn exists as a decentralized database hosted by thousands of nodes spread across the globe, hosted in a diverse set of environments and jurisdictions. All these nodes work together to create and maintain the global Ethereum database through a combination of cryptography and incentives. And the Tornado Cash smart contract is part of that global database. All this makes smart contracts, especially those like the original Tornado Cash contract (without a means to upgrade the code) practically unstoppable.

Not only is the Tornado Cash code unstoppable, it is accessible by anyone with an Ethereum account, meaning it is permissionless and cannot be censored. It can be banned, but enforcement of that ban is challenging and cannot be carried out on the technology itself. Anyone at any time could send funds from Tornado Cash to any Ethereum account, enlisting that account in prohibited activity through no fault of the owner. Someone could even send funds from Tornado Cash to Ethereum accounts controlled by the U.S. government, if there were any known ones.

Imposing sanctions against such a smart contract, rather than against entities using it for illicit purposes, is therefore neither reasonable for innocent users nor particularly effective. The sanctions can’t be enforced and could end up harming people who did nothing wrong in the first place. Yet we must face this new reality. At least for now.

Over the past week, we’ve seen a rallying cry among the cryptocurrency community to push for further decentralization and protection of user privacy. As it stands, the divide between the sanctions’ intentions and their consequences appear to be growing.

There is a possible technological solution, however,. Several projects are working to balance privacy and transparency through the use of zero-knowledge proofs, a cryptographic technique that allows one to prove a statement about a set of data without revealing the data.

For example, my company, Espresso Systems’ CAPE (Configurable Asset Privacy on Ethereum), is a smart-contract application that enables asset creators to configure who can see what regarding the custody and transfer of the assets they create. Similarly, on-chain identity products like Verite and Polygon ID’s zk-credentials can let their users prove they aren't sanctioned individuals without having to necessarily reveal their exact identity.

Combining these types of novel protocols that enable flexibility can help protect everyone’s privacy, no matter what strange lands the whirlwind of regulation ends up taking us to.

Read more: Stop Attacking DeFi Founders for Complying With the Tornado Cash Sanction