The Law Comes to ETH, Where Boundaries?

It’s summer, with those that matter relaxing on sunny rivieras to escape any burnout. So what better time to depose Boris Johnson, or indeed to sanction an ethereum smart contract.

No one is paying attention, right. Is then the sanctioning of Tornado Cash such a big event as some claim, or can we put it down to a one off?

In any matter of sufficient complexity, and this is certainly one which this space has been trying to grapple with for years, ultimately there isn’t any one person or anyone group that decides, but a general base consensus of what is reasonable.

What is the reasonable balance between privacy and many good things, and not wanting grandma’s savings to be stolen?

The solution we reached in 2016 is that the frontend is controllable, but the back-end is not. This comes as a surprise to some as the crypto space has grown considerably since then.

Thus when Aave and some other dapps blocked even ethereum’s co-founder, Vitalik Buterin, as he was sent 0.1 eth from the sanctioned Tornado Cash smart contract, there was the refrain that these are not defi, these are refi, regulated finance.

The Aave smart contract, however, did not block anyone. Buterin thus, who is very skilled, can still use it, just with the equivalent of a terminal interface rather than a convenient colorful website.

The website itself of course is not decentralized. It has a domain name, which is given through a centralized registra, or registry, and it also has servers which tend to be provided by specialized giant companies.

To fully decentralize it is possible, but is it desirable? The understanding so far has been that fiat checkpoints are sufficient for the desirable aspect. That a hacker or far worse, a robber, can get the crypto but then how will they get it out?

The transfer of such crypto on the blockchain can also be traceable, though it may require some resources, but for serious matters law enforcement has the capacity to follow through.

In this case presumably they were tracing the North Korean hackers, and presumably they could trace them only so far as them depositing to Tornado Cash.

We don’t know the sums involved. You can see who goes in and who gets out of Tornado, so for significant sums, with some wit, you should be able to determine to where they got out.

With the legal powers of law enforcement, you can even follow through all of them and de-anonymize at the fiat points, but of course the evidence would lack in the connection when innocents are mixed with criminals.

So presumably they thought this matter is sufficiently serious since it is state hackers, and thus why not just ban it completely?

Generally speaking, you don’t ban it completely because you have to strike a balance. Either Congress declares mixers in themselves as illegal, which it has not as far as we understand, or you develop the skills of digital detective work to bridge the gaps that certainly go far beyond mixing holistically speaking, especially where state actors are concerned.

Because the easy way out of let’s ban this and let’s ban that is easy, but you create a different sort of resource problem where routine compliance becomes just noise and banning something comes with the risk of the abuse of power, which erodes and potentially significantly both compliance and effectiveness to the point you end up with ingrained corruption as we see in many authoritarian countries.

Why This One?

So far, they haven’t actually banned much, if indeed anything, in the crypto space. Zcash, for example, uses zero knowledge proof at the protocol level to make onchain transfers untraceable, at least in theory.

Monero uses ring signatures and they too claim it can’t be traced. Both are very small compared to bitcoin with a combined market cap of just $4 billion. For reference, even AML and KYC did not apply to cryptos when bitcoin’s market cap was at the same level, though it did start applying around that point.

Monero has however faced hostility, and it is not listed on many exchanges. Yet the crypto itself is not illegal in US, or Europe, presumably because so far the fiat points are sufficient.

Bitcoin has many mixers, including most famously Wasabi which was ‘praised’ by Europol for its decentralization and privacy focused options.

Ethereum does also have other mixers, though no one quite calls them mixers as privacy might be just one component of a scaling smart contract for example.

So why Tornado? Well, we don’t know. We presume that’s what they came across when tracing these NK hackers. The Tornado devs also seem to be mostly Russian. The lead dev is against the war, but there is a war going on and so in picking this specific dapp, they may have expected some deference considering the wider context.

That allows us to put this down as a one off, and while CoinCenter has put out some decent arguments, it isn’t too clear that this specific case would be the best one for such arguments in a court of law.

The better argument may instead be that our boys are supported in the very serious matters they engage in, but they have to be careful when taking public actions as the public has not given a carta blanc.

Policy

One has to also consider that this isn’t our boys, though in this case that seems unlikely, but more the donkeys so to speak, bored bureaucrats with authoritarian complexes or worse, Janet Yellen trying to have some fun.

Because this sanction follows the first crypto sanction of just two bitcoin addresses back in 2018. That two was a serious matter involving ransomware, and notable only because the Office of Foreign Assets Control (OFAC) was for the first time asserting its right to impose sanctions on crypto.

That first was met with a second, and in this case there has been some backlash and debate, in part because Tornado airdropped Torn tokens to many ordinary ethereans, showing in some way the success of community building through the token model.

And so the question is what next? Where do you draw the line so that they know before hand what the cost would be?

Arguably if the Tornado devs didn’t just happen to be Russian – as awful as that might be to say, but that’s war for you – then this might have not been a bad place to draw the line by at the very least asking for an explanation as to why the fiat checkpoints are not sufficient.

They might well say it would have been sufficient if they were Americans, but it’s another state. Raising the question of whether they have control over the fiat checkpoints used, in which case how does the mixing even matter?

If instead they arguing it would have not been sufficient even for Americans because the mixer evades such checkpoints, then it isn’t clear whether the problem wouldn’t be a bit too big for a simple ban.

Not least because launching such smart contract is easy, and in the traditional world you of course have a web of companies, though we haven’t much come across Tornado Cash.

When checking new dapps, the preferred way nowadays seems to fund the address from an exchange. So we can’t track it any further, but law enforcement can.

It is easy thus to keep privacy from the public, but not at a level of privacy that a criminal might need. However, the ID data of many crypto exchanges has been hacked, and so this ‘compromise’ does not give the desired level of privacy to the public as it’s not just law enforcement that can access it.

Relegating mixers as a class thus to the sort of dark crypto web is not desirable as there may be instances where they might be useful, including for law enforcement itself which may sometime need to hide its ID, but the grey web might be a reasonable compromise.

Because there is of course a problem with complete anonymity as it might make some very bad things a lot easier, and plenty would probably want to feel comfortable holding crypto.

But a straight sanction seems to be the easy way out and though it finds some compliance this time due to the specific nature of this case, it is a heavy step that has to be taken only as a very last resort with any mistake potentially very costly especially considering the global nature of cryptos, which means support for such action is vital if the tool is not to become irrelevant.

As though some of the biggest crypto exchanges and dapps are in US, and that gives the US government influence, it is of course consensual influence, especially if the pen is angered. Making such decision a very heavy one.

Where the network itself is concerned, ethereum is and remains neutral. Some dapps may do whatever at the frontend, but the network itself can not discriminate at the protocol level. That’s for whatever is on top of it.

That’s in principle. Technically some argue that since Coinbase and other entities that offer staking are regulated, they have to import government policy to the protocol by in this case validators themselves sanctioning the smart contract.

Now in theory validators in consensus can even delete the smart contract, though they’d have to move to a new chain.

In addition entities like Coinbase may even like such sanctions burden as it increases more the barriers of entry for a competitor.

However, that would be one way for the United States to not have global influence on crypto, making such validator sanctioning an extremely high cost for little benefit to the point one can potentially foresee in decades hence that Congress even moves to pass an act of crypto protocol neutrality.

Because entities like Coinbase should not, at a validator level, interfere with the network as they would be forked due to the principle of protocol level neutrality.

It’s unneeded in any event, and even dapps don’t need to take the action they have as the sanction is probably aimed at fiat checkpoints which can do something about the matter.

Raising the question of how many hops from Tornado Cash land you in trouble, how many transfers to new addresses from an address that withdraws from Tornado Cash?

At validator level sanctions, the dapp would be made unusable so zero hops. But that can work for only extreme events as you need to fork the network and no one is going to fork over Tornado Cash.

Because although Coinbase and other US entities are validators, they can’t just change the rules. The whole network instead has to upgrade. Something that can be done for a very big extreme event, but for ‘petty’ things, and Tornado falls there and even worse things, in reality it remains the case as it always was that it’s at fiat checkpoints where you can actually enforce.

So, someone withdraws from Tornado, gets liquidated on say Compound, some innocent party now has this eth. This is about four hops.

Some say in four hops everyone is connected to Tornado Cash. Maybe an exaggeration, but this question does not quite have an easy answer, reverting the solution back to old fashion detective work.

Because the easy way out of just banning the smart contract is probably not very effective, although ordinary ethereans would probably no longer use the dapp, yet there are far more effective ways, especially for zk based Tornados, at a government level if the aim is to actually catch criminals.

Which leads us to speculate that maybe there are other reasons for this specific step in this case, although action against mixers has been taken before.

And since this is the criminal aspect of the law, there isn’t much to be said save for to clarify why the network has to be neutral, unlike the civil aspect with SEC where we can play.