Tornado Cash: what the US judges' decision changes

Wednesday, November 27, 2024

A US appeals court has ruled that an immutable smart contract is not 'property' and therefore not subject to sanction by the Office of Foreign Assets Control. In an opinion piece, lawyer William O'Rorke (ORWL) explains why this decision is important, without overturning everything.

On Tuesday, the US 5th Circuit Court of Appeals issued an important decision regarding the application of OFAC (Office of Foreign Assets Control) sanctions against Tornado Cash's smart contract. OFAC is the agency responsible for applying US international sanctions in the financial field.

As a reminder, Tornado Cash had been sanctioned in 2022 by OFAC due to its use for money laundering purposes, particularly in connection with North Korea (Lazarus group). Tornado Cash is a blender, i.e. a decentralised application that blends traceable funds on a blockchain to make them untraceable and confidential.

Usually, OFAC sanctions relate to assets, accounts, people and, sometimes, tangible property (buildings, cars, etc.) or intangible property (financial assets, crypto assets, software, etc.).

The particular feature of this sanction against Tornado Cash was that it affected the entire protocol, including the smart contracts that form the core of the protocol.

To challenge this measure, the plaintiffs raised one argument about the lawful use of mixers and a second, more important argument about the concept of property within the meaning of the rules applicable to OFAC.

The purpose of mixers is to anonymise transactions, enabling confidential use of a blockchain protocol. This confidentiality can be used to mask the illicit origin of funds, but it can also serve a legitimate purpose: the applicants were using this protocol to send crypto for sensitive causes (Ukraine, a political party) and to guarantee their online security.

From a legal point of view, the main argument is to point out that OFAC can only impose sanctions on people and property.

In the legal sense of the term, property refers to that which can be possessed. However, as the Court rightly points out, Tornado Cash's smart contracts are immutable and intangible. As such, they cannot be possessed, and do not correspond to an asset liable to be the subject of an OFAC sanction.

After an in-depth analysis of the operation of the protocol, the judges concluded that the administrative sanction measure was unlawful and had to be annulled.

No impact for co-founders

The main consequence of this decision for users could be the end of automatic sanctions, based on OFAC lists, for the use of Tornado Cash. On the other hand, regulated players will have to keep a close eye on flows from mixers, but on the basis of their obligations to combat money laundering and terrorist financing.

For the co-founders of Tornado Cash, this decision should not have a significant impact insofar as it concerns an administrative measure - can OFAC place an immutable smart contract under sanction - whereas criminal prosecution is based on the intent of the perpetrators.

While this decision is an undeniable victory against an administration that clearly exceeded its powers, it does not change the game for the sector.

This analysis is not investment advice. It has been prepared without taking into account your personal situation, particularly your financial situation, risk profile, and investment objectives.

Before investing in any product, investors should fully understand the risks involved and consult their own legal, tax, financial, and accounting advisors.

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