Cooperation with the US Treasury sanctions on Tornado Cash was most effective at the user level and less effective as it moved through the settlement chain.
Tornado Cash, the crypto aggregator blocklisted by the United States Treasury Department in 2022, has been the subject of a report by the Federal Reserve Bank of New York regarding the impact of sanctions. The report concluded that sanctions are generally effective, even in decentralized finance.
Ethereum is also affected by the report’s conclusions. The report asserts that the Ethereum network’s resistance to censorship and cooperation indicates its “fragility.”
Are Tornado Cash sanctions relevant to the smart contract protocol?
On August 8, 2022, the Office of Foreign Assets Control (OFAC) of the Treasury sanctioned addresses associated with the cryptocurrency mixer Tornado Cash. The decision was in response to the widespread money laundering operations facilitated by extending the movement of crypto funds on the blockchain. This was the initial instance of a computer protocol being approved.
According to the report, adopting Tornado Cash experienced a substantial decline after the sanction but progressively rebounded. Throughout the crypto community, there was a response as exchanges and other platforms suspended Tornado Cash, and industry groups defended it.
Just after the Tornado Cash sanctions were implemented, the Ethereum blockchain‘s consensus mechanism transitioned from proof-of-work to proof-of-stake. Proposers, also called validators in other contexts, receive blocks of transactions from builders on Ethereum.
Users tended to adhere to the sanctions on Tornado, as indicated by the NY Fed report. Large constructors also observed the sanctions, albeit to a slightly lesser extent. Block constructors disregard the sanctions out of conviction rather than for financial gain. Despite the report’s observation that the proposers’ behavior remained unchanged, they could have sorted out non-sanctions-compliant blocks.
What sanctions are relevant to blockchains?
The report reveals facts about Ethereum itself through its observations of the Tornado Cash sanction behavior:
“Our results suggest that censorship-resistance is fragile. Although various design choices of Ethereum were chosen to encourage decentralization, we find a fair level of concentration along the settlement chain and high dependence on few actors to facilitate the inclusion of Tornado Cash transactions.”
Tornado Cash has experienced a significant resurgence this year and continues to operate. In May, Alexey Pertsev, the protocol developer, was convicted of money laundering in the Netherlands. Roman Semenov and Roman Storm, the other developers behind Tornado, have been charged by the Justice Department with conspiracy to commit money laundering, conduct sanctions violations, and operate an unlicensed money-transmitting business.
Storm is currently undergoing trial and being held in detention. Semenov continues to reside in liberty.
