Why Tornado Cash Sanctions Won't Be Effective and How It's Related To My Teenage Memories of Michail Gorbachev

I was writing about Tornado Cash OFAC sanctions, but the draft felt unfinished and incomplete for a while. Then, a couple of weeks later, I learned that Michail Gorbachev, USSR's last leader, passed away. I was a teenager during his time, and he resigned and retired during my freshman year at the university.

We were making a lot of jokes during those times about how uneloquent and indecisive he was, how shy and clumsy he looked, and how his wife was probably making all the decisions behind the scene. But in all fairness, we felt like the world was becoming visibly safer and friendlier and the foreign nations and cultures felt closer and more human. He withdrew the Soviet Army from Afghanistan and concluded multiple Arms Reduction Treaties with the US. He also did not (almost) use force, when the USSR fell apart. He probably knew the difference between the things one can and cannot change.

Later I learned that the main reason why he started reforms was simply that the Soviet economy was collapsing and running out of money, central planning, and central resource allocation did not work, domestic production was incredibly inefficient, we had food rationing at times, goods and services produced were of extremely poor quality, and a lot of national resources and talents were wasted.?

My personal biggest lesson from his time is that the best use case for negotiations and diplomacy is actually to stop and prevent wars because it allows all the other economic players and individuals to act without fears, plan and invest long-term.

What we have seen recently from OFAC and?European political leaders is quite opposite –? very irrational and very short-term focused measures, that clearly don't allow anyone to reach their original goal, but create a lot of externalities and collateral damage. US crypto bill draft, updates to the securities definitions, Russian sanctions, and now Tornado Cash sanctions are counter-productive and make everyone clearly more concerned and anxious. Nobody knows what OFAC is going to do next but almost everyone agrees, it's probably not going to be helpful. And it's not a good thing.

So – what is so special about the Tornado Cash situation?

Crypto privacy mixer Tornado Cash was sanctioned by the U.S. Treasury Department in August 2022 because they believed that this decentralized smart contract allowed North Koreans, hackers, and other criminals to hide the traces of their blockchain transactions and possibly re-introduce their funds back into the blockchain ecosystem as "legit".?What it means now is that no individual or entity (if they want to be compliant with OFAC) can receive funds or send funds or transact with funds that come from the Tornado Cash smart contract.

Reportedly, only about 30% of the funds that flew through this contract were illicit, the rest of the funds were routed through this service by many DeFi projects and even individuals who prefer to?maintain their transactional privacy.

What is unusual about this measure:

• OFAC can normally sanction entities (namely, individuals or legal entities). This time they sanctioned a "service" (smart contract) that is not operated by a legal entity or by any individual. Essentially, everyone using this service is sanctioned.
• OFAC can normally sanction foreign nationals and foreign assets. They cannot directly sanction Americans. This time, many assets that flew through this service belonged to Americans and were nominated in the USDC (which is a stablecoin issued by the US entity, Circle).
• Since there is?no clarity around what exactly needs to happen, when a smart contract is sanctioned,?and who specifically needs to comply, the domino effect of fear and panic exploded. Yes,?it is expected that regulated financial institutions and VASPS would block transactions from the sanctioned service, however, what was a surprise for many was that GitHub suspended all?accounts of Tornado Cash, some miners and validators refused not just to validate transactions that have a Tornado Cash history, but also refuses to build on the top of the blocks with the previous transactions that involved?Tornado Cash smart contract.
• Many DeFi proponents are worried that crypto exchanges, which are also the key validators of Ethereum, will give in to pressure and impose protocol-level censorship (though Brian Armstrong, the CEO of Coinbase, actually tweeted that they would rather forego the validation business than censor transactions if it comes to this).

To me personally, this action is another example of how modern politicians try to weaponize not just financial services, but also the technical and infrastructure services underneath. If it continues, before we know it, AWS could stop offering their cloud computing services to miners of Ethereum, and Google search?could pretend that Tornado Cash never existed.?? In the meantime, the bad guys will find a new way to launder money (they always do).

My point is, that diplomatic and political actions add value when they bring clarity and allow people to plan long-term and act with confidence. OFAC triggered the opposite reaction.

What is your take on this?

Tune in to this?Compliance That Makes Sense podcast episode?to get additional insights!??