Why the US Treasury sanctioned crypto's most famous cash mixer Tornado Cash

This week, the U.S. Treasury sanctioned one of crypto's most popular money mixers and prohibited Americans from using it. Then, on Friday, one of the engineers behind that money mixer, Tornado Cash, was arrested by Dutch authorities.

The stakes could not be higher for crypto right now as, "What does freedom look like when it comes to your money?" no longer becomes a hypothetical question of debate, but literally whether key to whether a developer goes to jail. First, let's cover why this is so important — not just for the developer or project in question, or for crypto — but even for people who don't transact in crypto.

For starters, the government loves to monitor everything. That's not a disputed point. Increasingly, citizens everywhere are dealing with overreach when it comes to surveillance and infringements on our freedoms. Cameras constantly recording are one thing, but when it comes to money, it is increasingly difficult to do anything at all without being tracked.

In fact, you can't even withdraw more than $10,000 of your own money in the U.S. without your bank alerting the government via requirements established in the Bank Secrecy Act. Furthermore, not only is it a penalty not to report those transactions to the IRS, but it becomes a crime if you knowingly attempt to transact in increments just below $10,000 in order to skirt those Bank Secrecy requirements. If you recall, former House Speaker Dennis Hastert was arrested in the saga of his abuse of high-school boys years ago, but it wasn't actually why he was arrested. As I wrote at the time for CNBC, authorities first arrested him on structuring charges, as he withdrew and sent hush money to one of his accusers in amounts just below the reporting requirements.

And yes, obviously in that case, you'd be right to very much view government monitoring as a positive. But, when it comes to monitoring anyone moving money for non-nefarious reasons, should not reporting bank transactions above an arbitrary number really, by itself, be a crime? In crypto land — where privacy is generally held in the highest order, either by principle or paranoia of government overreach in its purest form — the answer is overwhelmingly, and almost always, "No."

The government has increasingly stepped up its interventions to bring crypto transactions under its purview of control and monitoring. (Image Source: Getty Images / OsakaWayne Studios)

Now, you might say, "OK, Zack. I know crypto people are paranoid about government overreach, that's why they use bitcoin in the first place." And yes, you would almost be right. But as I've clarified before, it's actually already really easy to track bitcoin transactions considering they are recorded on an open and public blockchain for anyone to see. So instead, people most concerned about privacy for their transactions in crypto turn to something called a "mixer."

There are a few that have been used over the years. First, there was Wasabi. Now, there is Tornado Cash. They both essentially function the same way: Send crypto in. Get untraceable crypto out.

So, let's say I want to buy something embarrassing, but I don't want anyone to see that it is me buying it. I could just use crypto in my wallet, but that wallet could be traced back to me (and then everyone knows I secretly love the band Creed.) So instead, I take my crypto and send it to Tornado Cash. I wait a little bit and then withdraw that crypto from Tornado Cash to a new wallet. It's now clean, untraceable crypto (and no one needs to know I spent all that money on Creed.)

Scott Stapp of Creed performs during My VH1 Awards in Los Angeles, California. I think the song was "Higher" — an absolute banger. (Image Source: Getty Images/Jeff Kravitz/FilmMagic, Inc)

Now, the uninitiated viewer of this might also say, "Hey, Zack, that sounds an awful lot like money laundering." And ... that comes down to how you define "money laundering." If you define money laundering as a catch-all term for obscuring transactions, then sure, it does sound an awful lot like money laundering. But, it's also a very terrifying future when the simple act of protecting your privacy becomes something the government tries to block you from.

To further that point. I have friends who openly talk about how they love using Tornado Cash. Frankly, it kind of confused me because they aren't criminals (though you could make the case they are paranoid.) In my research, I think I have used Tornado Cash. (I honestly can't remember if I completed my test transaction of $100 because with transaction fees on Ethereum I think I'd only get back like $90 and I felt like seeing if I could scrub $100 and get back $90 was a pretty stupid experiment.) But the point stands — not everyone using Tornado Cash is a criminal. Yet, at the same time, I will admit that some people using Tornado Cash definitely are criminals.

As I discussed last week, there are a lot of attacks on crypto bridges to make absurd amounts of money. The attack on the Ronin bridge this year allegedly netted the North Korean hacking group Lazarus about $600 million that they then funneled through Tornado Cash. So yes, criminals definitely use Tornado Cash. But innocent people interested in protecting their transactions from prying eyes also use Tornado Cash. So what should regulators do? You can answer that in a number of different ways — but if your answer is, "Arrest the people who built Tornado Cash!" you're either an idiot or a Dutch prosecutor.

Sorry. I got heated. Let's get back to the money laundering point. Because, yes, money laundering is illegal. And as we've established, even trying to get around bank reporting requirements by structuring transactions that fly under the limit of required reporting is also illegal. But if the money I am trying to move isn't illicitly earned — nor in an amount that's trying to skirt bank reporting requirement — surely that isn't illegal.

There are a lot of ways to define "money laundering," but I like the way Cornell's law school page breaks it down in plain English:

Money laundering refers to a financial transaction scheme that aims to conceal the identity, source, and destination of illicitly-obtained money. The money laundering process can be broken down into three stages. First, the illegal activity that garners the money places it in the launderer’s hands. Second, the launderer passes the money through a complex scheme of transactions to obscure who initially received the money from the criminal enterprise. Third, the scheme returns the money to the launderer in an obscure and indirect way.

Now, I should caveat this with the fact that I am not an attorney, but the cool thing that I've learned by building a crypto media company, is that even really smart attorneys are really dumb when it comes to crypto. So, that said, let's break this down: Tornado Cash obviously enables the latter points of that three-prong money laundering definition. It definitely constitutes a, "complex scheme of transactions," and definitely returns the money, "in and obscure and indirect way." But it definitely fails the first prong: "First, the illegal activity that garners the money places it in the launderer’s hands." (emphasis my own)

Again, I can obviously see why any government — in all its power, derived honestly from its citizens, or otherwise — would want to shut something like Tornado Cash down. Mixers make bringing criminals to justice infinitely harder, and there's a fair case to be made that doing so could be a net-negative for society. But, it also doesn't make it impossible for the government to bring criminals to justice.

Even after the alleged parties behind the hacking of crypto exchange Bitfinex used Wasabi to mix their transactions, the Department of Justice was still able to un-mix them using a key and years worth of investigative effort to recover $4.5 billion — the biggest financial seizure in the history of the DOJ.

So yes, is this story complicated? It's crypto, baby. That's why I started Crypto Uncomplicated. But I still stand by the point that the stakes really couldn't be higher.

What's most likely is that regulators will follow a similar path to their takedown of Napster. But that was easier because what that centralized site was enabling was the distribution of copyrighted content in the form of songs. By definition, the act of downloading a song and not paying for it was actually stealing. But in the case of Tornado Cash, users are sending their own money though it. In some cases, as was highlighted by one user in a joke this week, people can even send money through Tornado Cash to unwilling parties. That user sent money to Jimmy Fallon's public wallet and then joked that Fallon was now an operative of North Korea (lol.)

I would bet that sites like Google and others start making it harder to access Tornado Cash or block access altogether. It's of course always easy to go after where any site is hosted (especially when most are hosted on Amazon's cloud.) But what gets extremely interesting is what happens in the future. Decentralized cloud servers are already a thing in Web3. Regulators can't take something down when it's not hosted by a tech giant with shareholders or a business to protect. So this is about to get real messy, real quick.

One thing is clear, though: The privacy revolution is here.

Cyber punks worrying about government overreach seemed cute when they were talking about it in theory like a bunch of conspiracy theorists. But shit gets real when they attract the very government overreach they always warned about. That is now upon us. And the fun song and dance about "regulation" and "decentralization" as an abstract concept is now over as well.

Politicians who rode the wave of what Bitcoin unlocked when it came to breaking free of government overreach will likely now have to reap what they sow, or admit they never really believed in those things to begin with.

The lines are being drawn. Which side will you choose?

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