Crypto keeps picking the worst champions. Should the industry defend…

Proof of State is the Wednesday edition of Coins2Day Crypto where Leo Schwartz delivers insider insights on policy and regulation.

Crypto is often an industry of grifters hiding behind principles. Unlike other financial sectors, where the sole priority is maximizing returns, blockchain technology was built on ideals of decentralization and economic liberty, with the promise of some utopian future exploited to mask uncomfortable truths.

The Department of Justice filing charges last week against the two founders of Tornado Cash, a cryptocurrency mixer used to obscure the public nature of blockchain transactions, seems like the perfect example. The service, at least nominally, is open-source and decentralized, meaning it is not controlled by any individuals. It is a piece of software that anyone can interact with. When the Treasury Department moved to sanction the mixer last year owing to its favored status among money launderers, the action represented an unprecedented—and legitimately concerning—development of targeting software, not people or a company.

Many in the crypto industry jumped to the same conclusion after last week’s charges against two of Tornado Cash’s founders. In an op-ed for CoinDesk, two leaders of advocacy group DeFi Education Fund described the indictment as “commensurate with the government’s seeming disdain for privacy.” The think tank Coin Center argued that the DOJ’s action could criminalize the publication of software code.

Reading through the 37-page indictment, it felt like the critics were missing the forest for the trees. Without arguing whether the Tornado founders created the software because of some guiding light of privacy, the facts that prosecutors lay out make clear that the founders’ priority was maintaining their own profits while evading the law. Even if you believe that know-your-customer laws are an immoral abomination, the Tornado founders clearly understood that their software’s main function was to facilitate money launderers, including North Korea’s Lazarus Group. As in last year’s Ooki DAO case, they hid behind the guise of decentralization to obscure their own control over the project. They also made off like bandits, using VPNs to transfer out their proceeds of Tornado’s proprietary token and earn millions of dollars.

“We need to think what else they can accuse us of,” wrote one founder in an encrypted message. “We need to hand over the primary access, and then we can yell that the Worker is not the owner.”

I spoke with Laurel Loomis Rimon, a former DOJ prosecutor who worked on the first digital currency case back in the mid-2000s, before the emergence of Bitcoin. She said the Tornado Cash indictment doesn’t seem groundbreaking—in fact, she argued you could draw a clear line between her work on that original case in 2007 to last week’s, where prosecutors are not focused on regulatory questions, but whether the defendants conspired in agreement with others to launder funds.

“This is low-hanging fruit for the government,” she told me. “These are pretty egregious facts.”

One of the charges, conspiracy to operate an unlicensed money-transmitting business, does raise the question of whether Tornado Cash was, in fact, a money-transmitting business—an allegation that Coin Center took issue with, based on 2019 guidance from the Financial Crimes Enforcement Network, which seems to exempt anonymizing software providers. Rimon pushed back, saying that money transmitting boils down to whether you’re involved in the flow of funds, and whether the transactions would happen without the entity in question.

If the facts laid out by the prosecutors prove to be true, the Tornado Cash founders created a software program that facilitated money moving from one place to another—and were seemingly in charge of the product. Even if the DOJ is punting on the idea of whether a project can truly be decentralized, she cautioned that it may not matter. “The government,” she told me, “is not on board with the idea that human beings can create a platform that goes out, facilitates illegal conduct, and nobody is responsible for compliance.”

Leo Schwartz
[email protected]
@leomschwartz

DECENTRALIZED NEWS

The crypto firm Grayscale won its case against the SEC, potentially opening a pathway to a Bitcoin ETF and dealing a major blow to the Gary Gensler–led agency. (Coins2Day)

Robinhood split ways with market-making firm Jump Trading in early July, signaling the growing hesitancy of traditional finance firms to operate in crypto. (CoinDesk)

Tether found a new partner in the Bahamas-operating Britannia Bank & Trust, as the stablecoin giant struggles to find global banking access. (Bloomberg)

Elon Musk continues to amass money transmitter licenses across the U.S. As he seeks to turn X, formerly Twitter, into an “everything app.” (Cointelegraph)

Sam Bankman-Fried and prosecutors continue to battle over which evidence and witnesses—including some experts being paid up to $1,200 an hour—should be allowed at his upcoming trial. (Coins2Day)