Tornado Cash Sanctions: Can Ethereum Be Policed?

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Since Tornado Cash was sanctioned some days ago, the cryptoverse has been buzzing with rumors about how far protocols and businesses will go to comply with legal requirements.

A crucial question, “Can Ethereum Be Policed?”, is being tested beneath this discussion. The response can’t be answered with a simple “yes” or “no,” and it necessitates separating Ethereum the technology from the numerous applications and services built on top of it.

Services can be sanctioned. Access to data on Tornado Cash smart contracts has previously been controlled by Ethereum infrastructure providers like Infura and Alchemy. The USDC stablecoin’s operator, Circle, has started suspending transactions from accounts that have interacted with Tornado-affiliated addresses.

It’s not all bad news, either. The Ethereum protocol, which determines whether transactions spread to the rest of the network, hasn’t (yet) been subject to censorship. Miners will still include the transactions in blocks and spread them throughout the network if a U.S. person wants to move money around with Tornado Cash.

Checking Tornado Cash Sanctions

Regardless of how you feel about Tornado Cash services, it is not unexpected that so many businesses have leaped at the chance to abide by the penalties imposed by the United States Office of Foreign Assets Control (OFAC).

Since Tornado Cash was banned, it is absolutely reasonable—and probably even preferable—for Ethereum blockchain-based programs to restrict users who have access to it, according to CoinDesk’s Daniel Kuhn, who made this observation earlier this month. The alternative would probably expose significant portions of the Ethereum network to legal troubles; that would comprise the foundation groups constructing the emerging, alternative economy of decentralized finance (DeFi).

Federal authorities have previously detained Tornado Cash’s founder. By disobeying sanctions out of principle, Ethereum app developers and exchanges run the risk of jeopardizing everything they have worked so hard to achieve. This has the potential to put the entire ecosystem in danger.

The U.S. government’s directive on Tornado Cash, according to think tank Coin Center, is overly wide. “How can it be proper to add to the sanctions list not a person, or a person’s property, but instead an automated protocol not under anyone’s control?” Coin Center declared.

As stated by Coin Center, Tornado Cash’s smart contracts may possibly be copied (though this would still be extremely risky).

Ethereum users have been testing the reach of the penalties by sending money to celebrities using Tornado Cash as a form of protest (and comedic relief). Jimmy Fallon, for instance, will presumably no longer be able to use services that identify Tornado-linked wallets because he received a small amount of ETH from a Tornado address without doing anything.

This demonstrates to the pranksters how ill-defined these sanctions were, making them challenging to really implement. However, it also exemplifies how one must become rather technical in order to interpret the sanctions.

Even if they can’t actively “accept” a Tornado Cash transfer, should a person lose access to apps? What even does the term “use” Tornado Cash mean? On a protocol level, this is where things start to get interesting.

Sanction Tornado Cash, Not Ethereum Community

Remember that the Ethereum network, like other blockchains, depends on a community of miners to put together blocks and distribute them to the network. These miners are known as validators in the forthcoming proof-of-stake system. The mempool is a sizable collection of transactions that have not yet been confirmed when a user initiates a transaction on the Ethereum blockchain. By choosing transactions from the mempool and organizing them in some order, validators and miners put together blocks. They then put forward those blocks for confirmation by other nodes and their addition to the chain by the larger network.

Let’s now review the circumstances behind Tornado Cash. Would a validator be breaking the law if they included a Tornado Cash transaction to a block? While unlikely, there is some uncertainty in the solution to this query.

This has given rise to questions about whether the Ethereum network itself is vulnerable to censorship. Additionally, it has sparked a discussion on Twitter about how the Ethereum community would react if validators were to stop accepting Tornado Cash transactions.

OFAC Compliance in a “decentralized” Environment

As we’ve mentioned before, it’s getting harder to overlook centralization on Ethereum’s forthcoming proof-of-stake (PoS) network.

Over 66% of Beacon Chain validators, or those that “stake” Ether and manage the nodes that power Ethereum’s proof-of-state network, will abide by OFAC restrictions, according to predictions made by the ETH community on Twitter.

There hasn’t been any indication from these validators that they will really censor transactions up to this point. Even the possibility that governments would enforce it is unclear. However, the tweets highlight significant concerns about the potential effect that governments could have on the blockchain.

According to Jon Charbonneau, a research analyst at Delphi Digital, only one-third of validators would need to conspire with one another in order to disrupt the network. The network might conceivably be affected if all of these validators decide to ban Tornado Cash transactions by stopping them from being completed.

Tornado Cash Crisis: Too Much of a Bad Thing

Validators (or miners) have not yet given any indication that they have changed their behavior in accordance with the Tornado Cash requirements of the U.S. Treasury. Furthermore, even if necessary, it’s unclear whether validators would censor the chain.

The biggest Ethereum staking pool, Lido, distributes its stake among numerous validators. Lido’s community would need to recruit all of its validators or hire new ones if it decided that sanctions prevented them from completing Tornado Cash transactions.

Luke Youngblood, who helped develop Coinbase’s Ethereum staking products before founding the Polkadot-based Moonbeam protocol, told CoinDesk that he believes it is extremely improbable that the validators staked by Coinbase will ever filter transactions.

Youngblood points out that Coinbase’s entire staking infrastructure was put up outside of the United States, for starters. Youngblood believes that even if it weren’t, the business would rather shut down its staking service than censor transactions (and risk losing part of its staked ether as a penalty).

There are extra layers of complexity surrounding whether validators are proposing or creating a block, Charbonneau told CoinDesk.

Ethereum’s Move

Eventually, Ethereum will segregate the parties that construct blocks from those who suggest them to the larger network in order to address the so-called miner extractable value problem (MEV). MEV-boost, an interim feature that will be released alongside the Ethereum Merge in September, would allow validators to propose pre-built blocks from central “relayers” rather than building blocks themselves. Full proposer-builder separation (PBS) appears to be a couple of years away.

Gabriel Shapiro, the general counsel at Delphi, said that from a legal standpoint, proposers and builders might be seen differently.

Shapiro told CoinDesk that the legal definition of “facilitation” or “aiding/abetting” “can be pretty broad.” “Validators who do not propose a block containing a sanctioned [transaction], but who nevertheless sign an attestation for that block as part of the sequence of events leading to that block becoming finalized, may be guilty of facilitating or aiding/abetting the sanctioned [transaction] and may therefore be in violation of sanctions laws (or other laws, as applicable).”

Responses from the Ethereum community

Youngblood considers the entire discussion surrounding validators’ potential to censor transactions to be pointless. Spreading FUD (fear, uncertainty, and doubt) about businesses, whether genuine or false, is simply good engagement farming. It receives lots of likes and retweets, the user told CoinDesk.

Whether it’s FUD or not, the possibility of protocol-level censorship is being taken seriously. The prominent cryptocurrency investor, Eric Wall, asked the Ethereum community on Twitter to find out how it would react if validators started to censor transactions.

Currently, 61% of users have chosen Option X: “Burn their share via social consensus and consider the censorship an attack on Ethereum.”

This would entail forking to a whole new blockchain where the stake of the offending validator is removed or diminished.

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