How Will The Tornado Cash Sanction Affect DeFi?

U.S. Secretary of State Antony Blinken said on Aug. 8 that the country sanctioned Tornado Cash TORN/USD, a decentralized application on the Ethereum ETH/USD blockchain that allows the anonymous transfer of Bitcoin BTC/USD.

The reasoning behind it, as well as how it was executed, has angered the crypto community and may be a precursor of a serious government crackdown on the industry.

Let's look at the reasons behind the sanction and what it could signify for the future of decentralized finance.

What Is Tornado Cash?

Tornado Cash, launched in 2019, is one of the first fully decentralized apps on Ethereum to offer private transactions.

It accomplished this by first accepting user payments, combining them into a single address and allowing users to withdraw funds to a second Ethereum address.

Due to the mixture of Ethereum addresses, it was impossible to determine who the original owner was.

Tornado Cash offered a way for people who valued their privacy to invest in and utilize cryptocurrencies without having their transactions automatically made public on Ethereum, which makes every transaction public by default.

Motives Behind The Sanction

With Tornado Cash's assistance, more than $7 billion in user funds have already been mixed.

Despite the fact that the majority of these transactions were fully authentic and lawful, there have been some major hacks that have used Tornado Cash to launder stolen money.

For instance, the Axie Infinity AXS/USD Ronin Bridge hack, which happened in April 2020 and saw the loss of more than $400 million in cryptocurrencies, was utilized to launder the money via Tornado Cash.

Additionally, money was laundered via the protocol as a result of both the Nomad assault and the Harmony Bridge hack.

To make matters worse, the FBI determined the Ronin and Harmony breach was carried out by the Lazarus Group, a North Korean organization that has been sanctioned since 2019.

The Lazarus Group's use of Tornado Cash was the main rationale the U.S. provided for its decision to ban it.

The government assumed control of all Tornado Cash addresses, including the addresses for its smart contracts and donations, to sanction the decentralized application.

This means that anyone who transacts using Tornado Cash might be charged with a violation of the U.S. sanctions.

Crypto Community Furious

The move has drawn criticism from many in the crypto industry, who argue it amounts to "throwing the baby out with the bathwater" and is wrong to restrict a technology because it also serves certain unwanted purposes.

Additionally, Tornado Cash's decentralized nature ensures its smart contracts are always operational and useable and its website, which is maintained via decentralized storage systems, cannot be shut down.

To completely stop Tornado Cash, any government would need to shut down both the whole blockchain and the hundreds or perhaps thousands of servers that host it.

Moreover, hundreds of clones of Tornado Cash may be created, each with slight variations, because of the code's open-source nature and availability to everyone.

The government and privacy advocates will engage in an endless game of cat and mouse if the decentralized app is prohibited.

Consequences Of The Sanction

The stablecoin's parent company, Circle, instantly froze all USDC on Tornado Cash and prevented any associated addresses from using USDC when the ban was announced.

There has also been a lot of backlash over the fact one of the biggest and most reputable stablecoins has the ability to freeze anyone's account instantly.

The stablecoin is entirely centralized and is managed by a company with American headquarters.

Some business executives fear if USDC is forced to freeze additional assets, it might start a domino effect that obliterates DeFi.

For instance, USDC is utilized in Uniswap UNI/USD trading, Aave AAVE/USD loan collateralization and as a portion of the peg for the Dai DAI/USD stablecoin.

If the government made the decision to outright outlaw all three DeFi pillars as its next step, and USDC agreed, the whole DeFi industry would instantly collapse.

This is because decentralized trade would become impossible and money would become frozen.

It is one of the biggest threats to the future of decentralized finance.

Future Uncertain

As long as the Ethereum blockchain is operational, any protocol, including Tornado Cash, will never completely perish.

This decade is going to be highly important in terms of crypto law and additional restrictions and penalties are unavoidably coming.

Although it is unknown if this will have a significant effect on the market, it is evident that once they are released, these apps cannot be fully controlled.

This fact alone significantly enhances the value proposition of Ethereum and other layer 1 blockchains.