Interview: Circle Creates Dangerous Precedent By Blacklisting Tornado Cash Users, Says Stefan Rust

The U.S. Treasury Department recently blacklisted the use of Tornado Cash, an open source project that allows users to hide their transactions. They claim Tornado has been used by North Korean hackers to launder over $7 billion in stolen cryptocurrency since 2019.

In turn, Circle, issuers of the popular dollar-pegged USDC stablecoin, froze 75,000 USDC held by users with ties to Tornado Cash, according to Dune Analytics. 

In a blog post, Circle CEO Jeremy Allaire wrote: "On Monday, August 8, the systems we have in place to comply with applicable law, and government regulations worked. Centre, the consortium behind USDC, followed the US Treasury sanctions against Tornado Cash and blocked the related addresses."

To Allaire, this is a matter of compliance and trust. He added, "Trust is part of what sets us apart, and we have worked hard to earn it from the ecosystem and balance it with active policy and regulatory engagement in Washington and around the world. With trust comes great responsibility, and we intend to do the right thing."

Stefan Rust, a noted crypto advisor, former CEO of bitcoin.com and CEO of Laguna, a layer 1 blockchain and incubator which has launched trustednode.io, truflation.com and nuon.fi, believes that Circle’s move to ban users of Tornado Cash sets “an extremely dangerous precedent and should be a wake-up call for everybody working in the cryptocurrency industry.”

This move has put all the Tornado Cash and Ethereum wallet addresses associated with Tornado Cash on the U.S. Treasury Department’s list of Specially Designated Nationals and Blocked Persons List (SDN).

Rust warns that this blacklisting capability, which is written into the Ethereum Virtual Machine (EVM) token contracts, is a potential point of coercion.

“Right now, any user that has sent funds to a newly-banned Tornado smart contract finds themselves locked out of their USDC forever,” Rust said. 

With an Ethereum smart contract, tokens in a blacklisted address simply cannot be moved because the contract will fail if a transfer from that address is attempted. Rust believes that this move could start a trend of blacklisting and control that could be used by governments — and competing blockchain companies — around the world. 

“Imagine having a business where your closest competitor could shut you down by adding one row to a database it has complete control over,” Rust said. 

We interviewed Rust concerning the injured state of DeFi, the balance of regulation and the dangers of providing centralized control over digital assets to government entities. 

 

BZ: Is this a problem of over-regulation, lack of clarity in regulation, or something else?

Rust: “I think the bigger problem is really more around arbitrary determinations that are happening. There is no framework. It's built on archaic policies that were defined 100 years ago.

Blockchain technology is a threat to the monopoly that we have today, which is one currency defined by one government working with Wall Street.

The Office of Foreign Assets Control is going after tornado cash and banning wallet holders there. Why wouldn't you just track those wallet holders? Why wouldn't you just maintain and monitor them?

That’s what the Department of Justice did with Bitfinix when they went after the hackers that took 190,000 BTC. They followed the wallets where all those coins were. And as soon as they touched the wallets, they caught them (the scammers).”

If we lower regulatory guards on crypto, aren’t we likely to run into more disasters like Terra Network?

“Terra Luna is sort of a unique case. But Terra Luna was fed by regulated entities. You have Three Arrows (Capital), Celsius, and Voyager. Many of them leveraged and worked with Anchor Protocol (ANC) to provide about a 20% yield on USDT – and those entities were regulated. 

That is not the representation of real true DeFi. Celsius is still waiting for a lot of its collateral that is locked up because they have to pay back the loans that they took out. And until they pay back those loans, those collaterals are locked up based on the governance in the smart contracts. And if they can't pay, they have to wait till the price goes up so that they can buy more and then use that collateral to pay back the loans and get their collateral back. 

The downside in the industry is that fundraising is rewarded more than the actual development and building of products. And I think that is where we're flawed. Society doesn't have the patience to wait for a project to be built over two years, so we glorify it when a company raises $300 million. “

If users doing hedge farming were led by promises of unrealistic yields, how do we in the industry work with more realistic claims?

“I feel education is really important, and not in the sense of I'm going to tell you how to do it but in that, I tell you where to read up on and how to think critically about your investments.  In school, we teach you math, but we don't teach you what compounded interest is or how it works.

How do you educate the population and the people so that they know how to navigate all the resources available and can apply a certain level of critical thinking when they deploy their money? It's a long-term goal, and it will not happen overnight.”

What does the appropriate mix of information and regulation look like to you?

“I feel that we need to build new systems for modern society, and we need to allocate resources that are appropriate to be able to navigate and leverage those resources, leverage that infrastructure and systems to be able to stop the 2% or 5% of bad actors, not stop everybody else.

How do we, in a transparent world, bring forward the conversation around an algorithm about how to weigh the information we should be getting? If we can get together, let's mix all viable information and figure out the right outcome. That will bring back more consensus and compromise, which I think we've lost.”

What is your focus, and Laguna’s focus, in 2022?

“My focus is really on creating economic opportunity. I believe that the world is full of hope. This is the most exciting time to be alive. How do we manifest that self and create wealth for individuals that are participating and that are willing to learn and willing to experiment? If we find those people and grow communities around them, then I think there will be a significant amount of economic opportunity.”

Conclusion 

This is a cautionary tale of how government oversight can be used competitively by projects in the blockchain space – but, at best, this is the beginning of a conversation. One that will lead to more discussions with regulators and hopefully by like-minded projects in the blockchain space.

We certainly can do more to promote education, but it’s just not a safe assumption to assume that investors who lost their savings on LUNA tokens didn’t do research. In fact, many journalists, myself included, wrote positive stories about Terra Network before the big collapse.

The fact is that even the decentralized world of digital ownership that Web3 presents will need some form of clear accountability. That accountability starts with the claims made in the beginning when the project is first being sold to investors. 

The real solution may ultimately be some form of industry self-regulation and clearer guidelines from the US government, but more energy should be put into finding a solution that we can live with as an industry. The cost of waiting to produce such a solution – and of not questioning the wisdom of mixers like Tornado Cash which allows users to hide transactions – is that the regulations we refuse to devise for ourselves may be forced on us.

Cover image by JL G from Pixabay.