Onslaught of Virtual Currency Regulation and Friction

Written by: Fu Zhuorui

Perhaps no one thought that the sanction of Tornado Cash, a private transaction application a few weeks ago, would trigger such a The scale of the chain reaction, from the front-end shielding address of the DeFi application, to the arrest of the developer, to the impact on the anti-censorship of Ethereum, the world's largest decentralized ecological network, has far exceeded expectations.

Maybe everyone will have doubts, this is not the first time that cryptocurrency has encountered regulation, but why This regulation has even affected the foundation of the network? What is different about this sanction?

What is OFAC?

Established in 1950, the Office of Foreign Assets Control (OFAC) is an agency under the U.S. Department of the Treasury. Interested foreigners and organizations impose economic or trade sanctions, which have great power, relatively small reputation, and obvious effects of sanctions. Often being on the OFAC list will have a profound impact on the sanctioned targets.

OFAC was created out of an act of Congress passed in 1977 - the International Emergency Economic Powers Act (IEEPA ), the bill must first abide by the U.S. Constitution, so the act of exercising the powers related to the bill must also conform to the U.S. Constitution. IEEPA gives the President (the executive branch of the country) the power to declare a national emergency, thereby preventing persons and organizations under U.S. jurisdiction from engaging in any activities involving foreign powers that harm U.S. interests. IEEPA gives OFAC the power to block property, and at its core, "property." After 9/11, in order to better combat terrorist organizations financially, then US President Bush pushed Congress to pass another bill, the "American Patriot Act", which essentially expanded the executive powers proposed by IEEPA and gave OFAC a lot of big power. The act allows OFAC to block property "pending of an investigation" without having to offer an explanation or provide corroborating evidence.

Before OFAC began to swing the big stick of sanctions to the cryptocurrency and blockchain industry, OFAC's traditional sanctions were generally Individuals and organizations associated with sovereign states that ideologically challenge the United States. In October 2021, OFAC released the Sanctions Compliance Guide for the Virtual Currency Industry (Sanctions Compliance Guide for the Virtual Currency Industry), which reiterated the types of OFAC sanctions, which fall into four categories: i) Extensive commercial sanctions and blockades, currently mainly targeting Iran, North Korea, Cuba, Syria, Crimea. ii) Sanctions against a government or regime. iii) List system (currently, many virtual currency industry sanctions use the list system) iv) Industry system, targeting a specific industry in some foreign countries.

The first type of sanctions is the foundation of sanctions, but OFAC flexibly uses various sanctions to block all foreign trade of a sovereign country or region and economic behavior. Readers who have traveled to Iran, North Korea, etc. may feel that international bank transactions cannot be used in those countries, and all transfers to citizens of those countries cannot be processed through SWIFT. Since 1979, the United States has imposed comprehensive sanctions on Iran, prohibiting direct trade between the United States and Iran, prohibiting the sale of aircraft parts to Iranian airlines, and prohibiting oil trade. OFAC also directly freezes and confiscates the overseas assets of Iranian leaders , adding more than 700 Iran-related entities to the Specially Designated Nationalists List (SDNs), etc. The sanctions have had a far-reaching impact, severely damaging the Iranian economy and keeping the Iranian economy out of the world economy. One of the reasons for the temporary extradition of Meng Wanzhou by the United States is to investigate whether Huawei helped Iran evade sanctions. Currently, OFAC is investigating Kraken, the largest cryptocurrency trading platform, which has been under investigation since 2019, also because Kraken is suspected of circumventing sanctions on Iran. In addition, OFAC has sanctioned a number of persons or entities that attempt to circumvent sanctions. In March 2020, OFAC announced sanctions against two Chinese nationals for helping North Korea’s Lazarus Group evade sanctions and launder money through cryptocurrencies. Most of the sanctions are related to the first category of sanctions. The reason is that a certain behavior in a certain industry involves the sanctioned country, whether the behavior is intentional or unintentional, in the United States or not, with evidence or without evidence.

OFAC Sanctions Cryptocurrency Processes, Cases OFAC has released five elements of compliance (sanctions compliance program, SCP), which are i) management obligations ii) risk assessment iii) internal controls iv) testing and auditing, and v) training. Overall, OFAC's expectations are relatively high. If an enterprise wants to be compliant, it needs to have compliance and risk awareness from top to bottom, arrange internal personnel and departments to deal with OFAC compliance matters, and be careful not to be rash or unprepared touches the OFAC red line. Being on the SDN list can also change behavior, actively deploy compliance, and then apply to OFAC to be removed from the list. OFAC made it clear that the purpose of sanctions is not to permanently punish certain individuals or organizations, but to urge them to change their behavior and increase compliance. So, every year OFAC also removes many people and organizations that have made changes from the website.

In recent years, with the rise of decentralized cryptocurrencies and trading platforms, OFAC sanctions have repeatedly entered the industry . Although the theoretical essence of cryptocurrencies is decentralization, the more important trading platforms are US-compliant companies, and the founders may be related to the interests of the United States, and even the trading platform does not need to be related to the United States, as long as it appears in the transaction and "Iran" Anything related to "North Korea" that opposes OFAC's established sanctions is highly likely to be sanctioned by OFAC.

In September 2021, OFAC announced sanctions on Suex, a cryptocurrency trading platform actually operating in Russia, and listed it as an SDN. It is suspected of laundering money for cyberattacks, facilitating the illicit proceeds of at least eight ransomware variants. In April 2022, OFAC sanctioned mining Bitriver for helping the Russian government evade sanctions. In May 2022, OFAC has announced sanctions on Blender.io, a virtual currency mixing platform, on the grounds that the platform helped the North Korean government launder money and helped the North Korean Lazarus mentioned above to launder more than $20.5 million. OFAC freezes all of Blender's U.S. assets and prohibits U.S. individuals and entities from trading with Blender.

In addition, OFAC also frequently updates and lists new sanctioned individuals, including Iranians, Russians, Chinese People, because they use cryptocurrencies to launder money for sanctioned countries, and of course, they also use decentralized trading platforms to move criminal funds.

Before OFAC sanctioned Tornado Cash, the wallets and individuals listed by OFAC all had a certain degree of "legality" and complied with OFAC The logic of sanctions, and targeting centralized individuals, groups, etc., are mostly related to individual sanctioned countries such as Iran, North Korea, and Russia. Although there are complaints in the virtual currency industry, no logical loopholes have been found.

OFAC Sanctions Legality and Illegality of Tornado Cash

In August 2022, OFAC added the virtual currency mixing platform Tornado Cash to the SDN list, announcing the sanctions related to 44 Ethereum and USDC wallet addresses, on the grounds that the mixer was involved in money laundering, involving more than $7 billion worth of virtual currency Currency, the sanctions set off waves in the virtual currency circle.

Unlike the Sanction on Blender.io earlier this year, the Sanction on Tornado Cash is not sanctioning an "entity". When sanctioning Blender, OFAC listed in detail several websites and dozens of Bitcoin wallet addresses related to Blender, and Blender is a centralized entity. But Tornado Cash is not a centralized currency mixer, so firstly, this allows OFAC to deliberate on the source of power to sanction "entities", and secondly, it also makes it very difficult to sanction decentralized smart contracts like Tornado Cash. After the sanctions, U.S. citizens will not be able to use Tornado Cash.

Since OFAC sanctions are generally non-transparent, it is listed on the website claiming that the sanctions against "Tornado Cash" do not know the specifics Who is being sanctioned, is it an entity called Tornado Cash that is controlled by a natural person, or is it the entity that owns and operates the site, or is it the entity that raised the funds. Due to the decentralized nature of Tornado Cash, the sanctioned virtual currency wallets listed by OFAC cannot indicate that there are entities, legal persons, or natural persons behind these sanctioned wallets that can be sanctioned, because wallets installed on Ethereum smart contracts can It is not controlled by people, and the currency is automatically mixed according to the code. There is no evidence that the natural or legal entity that deployed Tornado Cash now controls the program. In the logic of Tornado Cash, users who mix coins can come from all corners of the country, but there is no central review team or mechanism to identify these customers, but this is not necessarily intentional, but the system and algorithm are automatically decentralized match and process. In this case, some lawyers think that whether OFAC can include an automatic agreement in SDN, is this situation unconstitutional?

If the sanctioned Tornado Cash is an entity, if the entity believes that the OFAC sanctions are unfair, it can defend itself through legal means and in the The lawsuit was filed in federal court. Since only entities can file lawsuits, and only entities can petition to be removed from the SDN list, is it unfair to sanction entities without a center? At the same time, sanctioning relevant wallets cannot change the automatic transaction behavior of the automatic algorithm, so does the sanction violate the original intention of OFAC, which is to prompt an organization or individual to change their behavior.

Cryptocurrency think tank Coin Center believes that OFAC’s sanction of Tornado Cash is beyond the authority of the organization, as the sanctions did not promote the “ Entity" without being able to effectively change behavior. Finally, it is not within the scope of the blockade of "property" stipulated by IEEPA, and it does not provide the procedural due process requirements stipulated in the US Constitution. Therefore, OFAC's behavior exceeds the administrative power granted by IEEPA.

Kraken CEO Jesse Powell thinks OFAC's sanctions against Tornado Cash may be "unconstitutional." After the Dutch government detained Tornado Cash founder Alex Pertsev, a rally of more than 50 people marched in Amsterdam on August 20 to protest against the detention and demand the release of Alek Pertsev. At present, lawyers who have doubts about OFAC’s sanctions are organizing forces to contact OFAC and trying to promote protests and lawsuits at the legal level.

The future of regulation and the Ethereum fork

Current Ethereum, which is on the cusp of forking, may also fight OFAC. If one day OFAC wants to review or sanction Ethereum after it has been converted to PoS (Proof of Stake), is it possible? OFAC can sanction the infrastructure "entity" that provides services to Ethereum, but if you want to sanction a decentralized protocol, you will also face problems. Faced with this problem, Ethereum founder Vitalik Buterin stated via Twitter on August 16, 2022 that the censorship system is an attack on the Ethereum protocol. If there is such a situation, he will choose to burn his shares through community consensus.

Some governments have found the logic and difficulty of regulating decentralized tools in a centralized way. EU Vice President Eva Kaili said in an interview with CoinDesk in August, "By design, DeFi lacks the characteristics of 'physical', at least in the way we are used to. Therefore, in this decentralized environment, we need Reconsider our approach to what constitutes an "entity" that will be liable in cases of misconduct".

In June 2022, affected by the collapse of UST, the European Union accelerated the legislation of the cryptocurrency industry and introduced the encryption bill MiCA, Stablecoin providers operating in Europe are required to provide reasonable white papers and ensure that the logic is feasible. Encrypted asset service providers in Europe are required to be authorized to operate in the EU. Large service providers must be supervised by the European Securities and Markets Authority. Stablecoin issuers must Keep a certain amount of reserves, etc. The Act is a watershed act for stablecoin regulation in Europe, many of which are similar to those governing traditional centralized financial service providers and banks. The European Union's Act regulates decentralized content as much as possible through nodes that can be regulated in the field that can be carried out.

Despite the passage of MiCA and the actions of OFAC, much of the conduct of the decentralized marketplace is currently not regulated, but This does not mean that regulators are not paying attention to this industry. Federal Reserve Vice Chairman Lael Brainard has long been critical of the development of virtual currencies, arguing that effective regulation is needed before the industry can become big. Federal Reserve Chairman Powell has also repeatedly stated in public that the United States may need a framework for the regulation of virtual currencies.

In contrast, some smaller regions and countries have slightly more relaxed laws. On February 28, 2022, the UAE passed the Virtual Property Law and established the Virtual Property Regulatory Authority (VARA). In addition to requiring companies that issue virtual currency to obtain a UAE license, it indicates that all virtual property companies in the UAE are subject to VARA. Outside of regulation, there are not too many clauses.

As the regulatory authorities increasingly strengthen the supervision of the blockchain industry and cryptocurrency, due to various reasons, geopolitics and legal It is also inevitable that it will increasingly enter this industry that should be decentralized in theory. Based on the growing geopolitical factors and the increase in international money laundering activities through cryptocurrencies, relevant regulators such as OFAC will also improve their regulatory methods to better achieve centralized political goals in decentralized groups.

References

https://www.coincenter.org/analysis-what-is-and-what-is-not-a-sanctionable-entity-in-the-tornado-cash-case/

https://siliconangle.com/2022/08/08/us-treasury-sanctions-cryptocurrency-mixing-service-tornado-cash/

https://cointelegraphcn.com/news /eu-agrees-on-mica-regulation-to-crack-down-on-crypto-and-stablecoins

https://www.pymnts.com/cryptocurrency/2022/ crypto-regulation-weekly-eus-landmark-mica-legislation-hits-stablecoins-hard/

https://zh-cn.bitcoinethereumnews.com/technology/vitalik-buterin- votes-to-burn-the-stakes-of-protocol-censors/

https://www.nytimes.com/2022/07/26/technology/kraken-crypto-iran.html

https://www.winston.com/en/global-trade-and-foreign-policy-insights/ofac-sanctions-a-second-virtual-currency-mixer.html

https://www.coindesk.com/tech/2022/08/17/tornado-cash-fallout-can-ethereum-be-censored/

https://cointelegraph.com/news/us-sanctions-strategy-and-crypto-the-cracks-are-showing-in-iran

https://cointelegraph.com /news/talking-with-eva-kaili-vp-of-the-european-parliament-on-mica-regulation

https://www.huntonprivacyblog.com/2022/04/07/dubai-issues-its-first-crypto-law-regulating-virtual-assets/

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