On 17 August 2023, the United States District Court for the Western District of Texas sided with the US Treasury in a lawsuit disputing the Treasury's authority to impose sanctions on the cryptocurrency mixer, Tornado Cash.
Cryptocurrency mixers, or 'tumblers', are services that mix users' cryptocurrencies together to allow users to transact on the blockchain while protecting their privacy. Mixers like Tornado Cash achieve this by pooling cryptocurrencies deposited by many users. The mixed funds can then be withdrawn by users to fresh digital wallets (i.e. unused wallets with no transaction history). Cryptocurrency mixers can also be exploited by bad actors seeking to obfuscate the transfer of illicit funds.
Tornado Cash was officially sanctioned by the US Treasury in August 2022, on the basis that Tornado Cash had indiscriminately facilitated illicit uses of the application, such as money laundering, tax evasion, and terrorism financing. The Treasury specifically cited Tornado Cash' use by the Lazarus Group, a North Korean state-sponsored hacking group, to launder hundreds of millions of dollars worth of virtual currency.
In a legal challenge brought by six individuals who alleged that the US Treasury's action to sanction Tornado Cash violated the First Amendment, arguing that they were denied the ability to engage in "socially valuable speech" as they would have used Tornado Cash to make anonymous donations to important social and political causes.
US District Judge Robert Pitman sided with the US Treasury on all of its arguments and granted summary judgment in the case, affirming that the Treasury was entitled to designate Tornado Cash under US sanctions regulations.
Justice Pitman raised several significant points in his judgment, in particular that:
the Tornado Cash protocol operated as an "association", comprising its founders, developers and its DAO, and therefore can be properly sanctioned as an "entity" under the International Emergency Economic Powers Act;
the smart contracts deployed by Tornado Cash constituted "property" being "a code-enabled species of unilateral contracts" and are therefore potentially subject to sanctions under the Treasury's broad regulatory definitions;
Tornado Cash had a beneficial interest in the deployed smart contracts because they provided it with a means of control and use of crypto-assets (from which the smart contracts could generate fees for the DAO). In so finding, the Court explicitly rejected the assertion that the smart contracts were "abstract and ownerless";
the Court was not sufficiently persuaded that OFAC's action in any way implicated First Amendment protections on free speech. Specifically, the Court held that the government had not imposed general restrictions on interacting with open source code, only the use of the code in question to conduct transactions; and
The plaintiffs have waived their claim that their inability to access Ether (the native cryptocurrency of the Ethereum blockchain) trapped in a Tornado Cash smart contract pool violated the Fifth Amendment (which protects individuals from having their property seized by the government without compensation).
Paul Grewal, the chief legal officer of cryptocurrency giant Coinbase, tweeted his support of the plaintiffs' claims in a series of posts:
Amid the clash between blockchain based innovations and existing regulation, Justice Pitman's decision again highlights that the Courts may adopt novel or broad approaches in seeking to attribute responsibility to persons involved in the development of open source code, smart contracts and DAOs. In this case, the Court sided with the US Treasury's view that Tornado Cash was an association of persons, rather than autonomous software. It remains to be seen whether the Plaintiffs will appeal the decision.
Blockchain businesses in the meantime need to be carefully advised to meet their compliance obligations, particularly in relation to the application of financial services and sanctions laws. The broader questions raised by this case over privacy as a human right are likely to remain a subject of intense debate.
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