Ethereum Entities Largely Complied With Tornado Cash Sanctions, NY Fed Paper Says

As a seasoned analyst with years of experience in the digital assets sector and a keen eye for regulatory developments, I find this report from the NY Fed intriguing. The cooperation shown by Ethereum block builders in adhering to sanctions against Tornado Cash is a clear indication that the landscape of decentralized finance is evolving, albeit with some resistance.

Builders of Ethereum blocks have generally complied with restrictions imposed on Tornado Cash, according to a recent report by the Federal Reserve Bank of New York, although it’s noted that there’s still some activity occurring within this cryptocurrency mixer.

On Wednesday, a research paper was released by the New York Federal Reserve to assess how the Office of Foreign Assets Control’s sanctions on Tornado Cash influenced its utilization. Mixer services are created to safeguard privacy by masking the source and destination of transactions; however, organizations such as OFAC have been scrutinizing these platforms because they have been employed by criminal entities, including North Korea. In August 2022, the U.S. Department of the Treasury prohibited any American individuals from interacting with Tornado Cash.

In the legal proceedings underway, Roman Storm, a key figure in the Tornado Cash development team, is being questioned about his involvement with the project. The opposing sides, comprising prosecutors and defense lawyers, are debating whether Tornado Cash should be categorized as a software tool or a service. Earlier this year, another developer associated with it, Alexey Pertsev, was found guilty in the Netherlands on comparable charges.

On Wednesdays, the newspaper proposed an interesting point: Blockchain validators directly connected to a transaction (downstream) often tend to cooperate, especially following a court decision backing the penalties. However, as one moves further away from where the transaction began (nodes), they become less inclined to collaborate.

In the study, they used the court decision in August 2023 that supported OFAC as a starting point. This finding revealed immediate changes in behavior from major construction companies, suggesting they adopted a more collaborative approach post-decision. This supports the notion that regulatory clarity plays a crucial role in determining whether to cooperate.

The study noted a provision stating it assessed compliance with sanctions, but these sanctions might not affect individuals who are neither U.S. citizens nor residents, or any entities outside the country. In simpler terms, failing to cooperate doesn’t automatically imply that someone is using Tornado Cash illegally under the sanctions.

In the specified timeframe, the research found that the combined worth and quantity of transactions in Tornado Cash significantly decreased. Remarkably, a single entity accounted for the majority of blocks carrying funds sent via this mixing service.

While Tornado Cash transactions are still being processed, the platform’s ability to withstand censorship seems less robust than suggested by the volume of transactions, according to the report.