Gavel with money on background

Coinbase funding Tornado Cash users’ lawsuit against US Treasury Department

Coinbase (NASDAQ: COIN) is reportedly funding a lawsuit by a group of Tornado Cash users and its own employees against the U.S. Treasury Department. Treasury’s Office of Foreign Assets Control (OFAC) sanctioned the Ethereum-based “coin mixer” a few weeks ago, locking out U.S. users and banning addresses that used the service.

Treasury alleges that US$7 billion has been laundered through Tornado Cash and that a North Korean government-sponsored hacking group has used it. In theory, the sanctions would “blacklist” every Ethereum address that has interacted with the mixer, leading some to speculate that even addresses that had received unsolicited payments from a Tornado Cash address might also be banned.

United States based users who had funds in Tornado Cash before the sanctions are now unable to access those funds, although the government has not attempted to seize them. There has also been a debate within the Ethereum user community over whether miners complying with the sanctions should be blacklisted from the network.

It’s the first time a government authority has moved to sanction open-source software rather than another government, business, organization, or individual. Tornado Cash was not a company, meaning Treasury is applying measures very broadly against a piece of infrastructure and its entire user base.

Coinbase’s Chief Legal Officer Paul Grewal said the sanctions “set a dangerous precedent” and have a chilling effect on software development. He drew a comparison between the Treasury’s sanctions and a government authority punishing all users of a highway due to a few criminals driving on it.

A group of six plaintiffs, which includes some Coinbase employees, is suing Treasury and has accused the department of exceeding its authority. It seeks to challenge the sanctions against Tornado Cash in general, and remove the six users from sanctions lists. Coinbase said banning all users of a service, which in this case is simply a piece of software, is like using “a hammer instead of a scalpel” and puts legitimate users of a mixing service at risk.

While criminals have for years made good use of mixers to launder their ill-gotten gains, others use them for privacy reasons. In a blog post explaining why it’s bankrolling the lawsuit, Coinbase CEO Brian Armstrong gave three examples from plaintiffs who suffered losses or personal security risks while using Tornado Cash legitimately. Armstrong wrote:

“At Coinbase, we’ve been fighting illicit activity since the very beginning, and while we share Treasury’s commitment to fighting crime, we believe this action harms innocent people and threatens the future of decentralized finance (DeFi) and web3 specifically.”

Getting serious about coin mixers

Western governments have indicated they mean business with their actions against Tornado Cash.

Apart from the U.S. Treasury’s sanctions, Tornado Cash protocol developer Alexey Pertsev is currently sitting in a Dutch prison after being arrested by the Netherlands’ Fiscal Information and Investigation Service in August 2022. Pertsev has been denied bail yet has not (so far) been charged with any crime. It’s also alleged he previously worked for a firm with ties to Russia’s FSB.

Coin mixers like Tornado Cash obfuscate blockchain-based transactions by pooling funds deposited by users and returning them to new addresses. This breaks the chain of transaction records a blockchain investigator might use to follow a money trail in pursuit of a criminal or corruption.

Similar arguments about legitimate vs. illegitimate users occurred in 2017 when a group of six U.S. law enforcement agencies shut down the BTC-e digital asset exchange, seizing all user funds. However, BTC-e was a centralized entity, which means it had operators, a website, and its own online wallets. Tornado Cash is merely software that shuffles funds between different addresses, leaving governments with nothing to target other than its developers and all users.

Some, including Bitcoin creator Dr. Craig S. Wright, have cautioned against using coin mixers for several years now. They correctly point out that using mixers (even legitimately) is illegal since there is no way to determine which funds are there for criminal purposes and which aren’t. This, in practice, taints all fund units in the pool. To put it somewhat crudely—if someone urinates in a jacuzzi, would you still want to jump in, despite knowing that 99.99% of the liquid in there was still water?

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