Tornado Cash is designated as the first target of an OFAC action against a decentralized platform.

OFAC Designates Tornado Cash in First Action Against

On August 8, 2022,
The US Department of the Treasury’s Office of Foreign Assets Control (OFAC) announced sanctions against Tornado Cash, a decentralized digital asset mixer. This is the first time OFAC has targeted an on-chain decentralized protocol.

OFAC announced that Tornado Cash was used to launder more than $7 billion worth of virtual currency, including $455 million stolen by the Lazarus Group, a North Korean-backed hacking group.

Executive Order – Control

Tornado Cash was added to OFAC’s Specially Designated Nationals and Blocked Persons (SDN List) in accordance with Executive Order (EO) 13694, “Blocking the Property of Certain Persons Engaged in Significant Malicious Cyber-Enabled Activities.” When an SDN’s property or interests in property are inside the United States or in the ownership or control of a US person, they must be blocked (i.e., frozen), and US individuals are typically barred from engaging with SDNs.

Furthermore, EO 13694 allows for the SDN designation of anybody who has “materially helped, sponsored, or given financial, material, or technical assistance for, or products or services in support of… any individual whose property and interests in property are banned under to this order.” While the application of so-called “secondary sanctions” of this kind is discretionary, this clause indicates that any individual, even a non-US person operating outside the US, is at danger if they continue to deal with Tornado Cash.

What it Means for Customers and Third-Party Participants

Tornado Cash emphasizes the need of carefully analyzing the safeguards in place at digital asset platforms before utilizing or engaging with the platform in any other way (sending tokens to or receiving tokens from the platform on behalf of a customer). Sanctions compliance procedures differ significantly between digital asset platforms, and this variation is more obvious in decentralized environments, where it might be more difficult for the platform to establish measures and for third parties to receive information on the measures in place. Fortunately, a growing variety of technologies, including blockchain analytics, are becoming accessible to help business analyze the relative risks associated with a specific platform, including decentralized platforms.

As previously stated, OFAC has released advice detailing its expectations for sanctions compliance procedures for the “virtual currency business.” The guideline describes a number of elements that should be included in a comprehensive compliance program. Companies dealing with digital assets should, among other things, conduct a detailed risk assessment that considers the platforms with which they interact, implement measures to identify and mitigate risky relationships, use transaction monitoring and investigation tools, and implement procedures to identify and act on risk indicators and red flags, some of which are enumerated in the guidance. While OFAC’s guidelines does not target decentralized platforms directly, the Tornado Cash case emphasizes the significance of building a thorough sanctions compliance program across all areas of the digital asset ecosystem.

What Does It Mean for Developers?

The action has significant ramifications for decentralized platform developers. It specifically states that decentralized projects that begin without addressing sanctions compliance mechanisms risk being designated by OFAC, jeopardizing the project’s sustainability and posing legal dangers to anybody dealing with it, including the developers. While many doubts remain about OFAC’s attitude to DeFi, the Tornado Cash action sends a clear message that OFAC will pursue enterprises involved in criminal behavior regardless of whether they are centralized or decentralized.

Historically, decentralized protocols have struggled to develop or enforce sanctions compliance procedures. However, developers are increasingly exploring for novel solutions, such as incorporating user screening techniques into protocol code. This is likely to continue as developers seek strategies to protect their projects from potential OFAC action. According to Secretary Nelson’s remarks on the Tornado Cash designation, the Treasury Department thinks that some fundamental compliance procedures are attainable.

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