Another spin in the crypto sanctions twister

Aug 24, 2022

By Sam Sutton, Kate Davidson and Aubree Eliza Weaver

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Tornado Cash has now entered the Washington spin cycle.

The Treasury Department's Aug. 8 sanctioning of the decentralized mixing service, which is used to obfuscate crypto transactions on the Ethereum blockchain, quickly exploded into a full-bore crisis for decentralized finance developers, privacy advocates and other pro-crypto groups who said it could be a harbinger of future crackdowns.

Two weeks later, congressional leaders are starting to take note.

"OFAC – they don't know how to deal with this thing," said Rep. Tom Emmer (R-Minn.), who sent a letter on Tuesday to Secretary Janet Yellen demanding more information about the Treasury's Office of Foreign Assets Control's (OFAC) case against Tornado. "So they're going to err — it appears — on the side of potentially infringing on the privacy and free speech of law-abiding Americans. And I think that's wrong."

Emmer, who also chairs the National Republican Congressional Committee, said, "OFAC has to figure out how to get some other tools to deal with the bad actors."

Founded in 2019, Tornado Cash fell out of Treasury's good graces after North Korean hackers allegedly used the protocol to launder hundreds of millions of dollars in stolen digital assets. This wasn't the first time OFAC targeted mixing services, having previously identified Blender.io as a washing machine for other Russia and North Korea-backed criminal actors.

But while few pushed back on the sanctions against Blender.io — a centralized entity that purportedly took custody of users' crypto before spitting it back out — Treasury's blacklisting of Tornado Cash targeted open-source software that its developers say they no longer control.

Functionally, Tornado's now an anonymizing perpetual motion machine: "Decentralized and unstoppable, as long as Ethereum isn't changed or taken down," the founders wrote in a May 2020 blog post . Tornado co-founder Roman Semenov emphasized that point as fears mounted over the use of crypto to evade sanctions – particularly following Russia's invasion of Ukraine. "There's not much we can do" to restrict transactions on the protocol, he told Bloomberg in March.

Treasury has said that the sanctions targeting Tornado Cash, including the entities that maintain the protocol and oversaw upgrades, are no different than those that have been applied to other crypto entities over the years.

DeFi proponents and crypto advocacy groups say that oversimplifies the matter, and that blacklisting code – rather than a specific business or individuals – amounts to an assault on free speech and due process.

Coin Center, a crypto-focused Washington think tank, has already said it's exploring a legal challenge on due process grounds. (Notably, as POLITICO's Ben Schreckinger pointed out last week , there is precedent for First Amendment protections applying to the publication of cryptographic code.)

To be sure, Tornado can and has been used by legitimate actors to privatize otherwise traceable transactions on Ethereum's public ledger. The blockchain analysis firm Chainalysis reported earlier this month that roughly two-thirds of the crypto that's been routed through the service came from centralized exchanges or DeFi platforms.

But that same report noted that almost 30 percent of that volume was either stolen or sent there by groups that were eventually sanctioned.

And therein lies the rub. The privacy tools that benefit normal crypto traders can also be used by criminals. Criminals took note en masse.

Tornado's decentralized code was "not a clean fit" with anti-money laundering and know-your-customer rules, said former CFTC Commissioner Dawn Stump, who was recently hired as a strategic advisor for the blockchain analytics firm Solidus Labs.

"Authorities have taken — and will continue to take — a really keen interest in that AML-KYC element that makes our markets solid," she said. "There will be more done in that space."

That said, determining how authorities move forward with enforcement actions or sanctions against ethereal pieces of software that are no longer controlled by a core group of developers is a much more difficult question.

"I would be well over my skis if I pretended to know the ins and outs of what OFAC is doing there," Stump added.

IT'S WEDNESDAY — And the bars in Jackson Hole are bracing for what's coming. Send tips, story ideas and feedback to kdavidson@politico.com, ssutton@politico.com or aweaver@politico.com.

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Driving the Day

Durable goods data released at 8:30 a.m. … Pending home sales data released at 10 a.m. ... The Bipartisan Policy Center holds a virtual discussion on blockchain and crypto policy at 2 p.m.

WHITE HOUSE BUDGET UPDATE — From Kate: "The Biden administration is projecting a record decline in budget deficits this year as federal tax receipts outpace expectations and spending on pandemic aid programs wanes. The budget gap for fiscal 2022 will total an estimated $1 trillion — $1.7 trillion less than the deficit last year and about $400 billion less than officials projected in March , according to the White House's mid-year budget update released Tuesday. That would be the lowest annual deficit since 2019, before the pandemic plunged the U.S. into a deep recession and prompted a wave of government spending to cushion the economy."

WHISTLEBLOWER 'MUDGE' HITS TWITTER AMID MUSK LAWSUIT — WaPo's Joseph Menn, Elizabeth Dwoskin and Cat Zakrzewski: "Twitter executives deceived federal regulators and the company's own board of directors about ' extreme, egregious deficiencies ' in its defenses against hackers, as well as its meager efforts to fight spam, according to an explosive whistleblower complaint from its former security chief."

From POLITICO's Rebecca Kern: "The whistleblower complaint could complicate the lawsuit that Twitter filed against [Elon] Musk for attempting to break his agreement to buy the company for $44 billion. Musk has alleged that the company has severely undercounted the number of spam and bots on the platform. [Peiter] Zatko said in the complaint that current Twitter CEO Parag Agrawal was 'lying' when he tweeted that the company was encouraged to find and take down spam as possible."

ICYMI: PENN WHARTON BUDGET MODEL ON STUDENT DEBT— Forgiving federal college student loan debt — up to $10,000 for borrowers with incomes below $125,000 a year — would cost the government $300 billion over the next decade, according to an analysis the Penn Wharton Budget Model released Tuesday. And most of the benefit would go to borrowers in the top 60 percent of the income distribution.

DROP IN GAS PRICES BLUNTS GOP WEAPON — Bloomberg's Ari Natter: "Republicans who have been using eye-popping gasoline prices as a potent political tool to bash Democrats in the run-up to the midterm election have a problem: Steadily falling prices at the pump."

BAD TIMING — NYT's Jim Tankersley: Pandemic aid "programs helped the U.S. economy recover far more quickly than many economists had expected, but they have run their course as prices soar at the fastest pace in 40 years. … While the extent to which the rescue package fed inflation remains a matter of disagreement, almost no one, in Washington or on the front lines of helping vulnerable people across the country, expects another round of federal aid even if the economy tips into a recession."

Economy

ADP REPORT REVAMP — POLITICO's Eleanor Mueller: "Payroll giant ADP is transforming its closely watched forecasts of the federal government's monthly jobs report into a wide-ranging and independent analysis of the labor market that draws on the breadth of its own data … Because it is based on payroll data — what [ADP Chief Economist Nela] Richardson called 'the biggest real-time crowdsourcing' in the U.S. — rather than the monthly establishment survey, the firm says it could be more up-to-date and, as a result, more useful than the Bureau of Labor Statistics' release."

NEW HOME SALES SLIDE — Bloomberg's Reade Pickert: "Sales of new US homes fell in July for the sixth time this year to the slowest pace since early 2016, extending a months-long deterioration in the housing market fueled by high borrowing costs and a pullback in demand."

GOOGLE "DENOMINATOR EFFECT" — Bloomberg's Janet Lorin: "Endowments lost a median 10.2% before fees for the 12 months through June, according to data to be published Tuesday by Wilshire Trust Universe Comparison Service. The largest funds -- those with assets of more than $500 million — fared substantially better, with a slight gain of 0.9%. "

Fed File

IS THAT BOB PETTIT? BECAUSE I SEE SOME ST. LOUIS HAWKS — Reuters: "The boards of directors of the Minneapolis and St. Louis Federal Reserve banks voted in mid-July for a full-percentage-point increase in the rate charged to commercial banks for emergency loans, minutes of their discount rate meetings showed on Tuesday."

Markets

THE ENERGY FROM THE CROWD — WSJ's Karen Langley: "The summer's market rally has begun to lure investors back into stock funds. Investors funneled a net $11.7 billion into equity mutual funds and exchange-traded funds over the two-week period ended last Wednesday, according to Refinitiv Lipper data."

RIP — WSJ's Gregory Zuckerman: "Julian H. Robertson Jr., a pioneering hedge-fund investor, has died at age 90."

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Crypto

FLATLINERS — Has interest in crypto stagnated? Last September, when interest in digital assets like Bitcoin and Ether was approaching its peak, around 16 percent of Americans surveyed by Pew Research Center said they had invested, transacted or used cryptocurrencies. In an updated survey taken last month, the percentage of Americans who said they had used crypto was unchanged. "This lack of overall change comes despite strong attention to crypto in the news," Pew's Michelle Faverio and Navid Massarat wrote in a research note published on Tuesday.

Notably, of those who said they had dabbled in digital assets, slightly less than half said their investments performed worse than expected.

CELSIUS COUNTERSUES — Bloomberg's Jeremy Hill: "Celsius, which filed for bankruptcy last month after freezing customer assets, alleges Keyfi Inc. and founder Jason Stone lied about his investing prowess and was incompetent in managing Celsius assets. The crypto lender also accused Stone of outright theft … The allegations come after Stone sued Celsius last month, accusing the crypto lender of fraud and cheating him out of potentially hundreds of millions of dollars in pay."

Fly Around

Business activity in Europe and Japan fell in August, according to new surveys, pointing to a sharp slowdown in global economic growth as higher prices weaken consumer demand and the war in Ukraine scrambles supply chains. — WSJ's Paul Hannon

Russia's economy has avoided the meltdown many predicted after Moscow sent its forces into Ukraine six months ago, with higher prices for its oil exports cushioning the impact of Western sanctions, but hardships are emerging for some Russians. — Reuters' Andrey Ostrukh

Australia, credited with spreading avocado on toast around the world, is creaking under a mountain of the green, pear-shaped fruit. — WSJ's Mike Cherney and Allison Prang

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