The U.S. Treasury Department’s decision to crack down on cryptocurrency platform Tornado Cash for allegedly being used to launder stolen funds—and the subsequent freezing of millions of dollars in assets by one of the largest U.S. stablecoins in compliance with the order—has prompted concerns of excessive government pressure from many crypto participants, particularly those in the decentralized finance sector.
Citing these U.S. sanctions against Tornado Cash, Dutch authorities Friday said they had arrested a suspected developer of Tornado Cash in Amsterdam on Wednesday, alleging the 29-year-old man is involved in concealing criminal transactions and facilitating money laundering through Tornado Cash. The Dutch authorities in a statement didn’t disclose the suspect’s identity and said they aren’t ruling out more arrests.
The Treasury Department’s action Monday against Tornado Cash, a platform based on open-source, self-running software protocols, is unprecedented, crypto industry participants add, as the U.S. has previously only sanctioned wallet addresses and centralized services.
The U.S. Treasury Department accused Tornado Cash, a so-called mixer platform that enables users to exchange cryptocurrencies with relative anonymity, of laundering billions of dollars in virtual currency, including $455 million allegedly stolen by North Korean hackers. The Treasury also identified and blacklisted dozens of wallet addresses associated with Tornado Cash. The sanctions block all property held by the platform under U.S. jurisdiction and bar U.S. companies and individuals from transacting business with it.
Crypto industry analysts say the sanctioning of protocols—essentially computer code—has become a key policy issue for the industry, which is increasingly concerned about the impact of broadening government intervention on the potential growth of crypto and the additional burden of compliance in a sector that sells itself on its privacy and decentralization.
“It’s a new development in crypto and will have deep implications down the line,” Miller Whitehouse-Levine, policy director at research and advocacy group DeFi Education Fund, said. “The industry’s impression is that the U.S. government is pivoting from focusing on punishing bad actors to policing the protocols now.”
As a result of Monday’s U.S. action against Tornado Cash, a total of roughly $424.28 million in digital assets were blocked from transacting as of Wednesday, according to data from blockchain analytics provider TRM Labs Inc.
Tornado Cash co-founder Roman Semenov didn’t immediately respond to requests for comment.
Circle Internet Financial Ltd., the crypto-focused firm that manages USD Coin, the second-largest stablecoin by global market capitalization, on Tuesday said it has blacklisted some Tornado Cash wallet addresses and restricted the movement of USDC funds in the blacklisted addresses, in compliance with the sanctions requirements.
Stablecoins, such as USDC, which look to peg their value to an external asset or benchmarks, underpin the DeFi ecosystem, as most transactions are priced in dollars.
Crypto observers said that even though it was appropriate for Circle to comply with the sanctions requirements, they are concerned with the downstream effects of the need to comply with such legal obligations.
Circle Chief Executive
said on Twitter that while his company is complying with the sanctions, “the regulatory intervention in this case crossed a major threshold in the history of the internet, and the history of open blockchain finance, with a major government obliging parties to outright block or limit the functioning of open-source software on the internet.”
DeFi protocols, an umbrella term for financial services offered on public blockchains, are made possible by smart contracts, which can automatically move crypto around based on rules enshrined in computer code. They have allowed crypto enthusiasts to replicate most functions of Wall Street without the assistance of Wall Street.
Enforcing the sanctions could also be difficult. People have been sending small amounts of Ethereum through a Tornado Cash smart contract to several celebrities, said DeFi Education Fund’s Mr. Whitehouse-Levine, presumably to prove a point that it is difficult to shut down an open-source software.
Mark Hull, head of growth at DeFi project Hubble Protocol, said the action taken against Tornado Cash and the ensuing freezing of assets by Circle, while a relatively small slice of the ecosystem, highlight how regulatory scrutiny can have a big impact on the industry. He said crypto users believe that blockchain is meant to be resistant to government censorship and centralized influence, including sanctions. But the reliance on centralized tokens, such as the USDC, can alter that equation, according to Mr. Hull.
“What this has shown, while it’s a drop in the ocean of what could happen, if we get to [a situation where] billions of dollars in stablecoin assets are frozen, that can destroy crypto as we know it now,” he said. “That’s absolutely an existential risk to crypto and defi as we know it.”
—Vicky Huang contributed to this article.
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