In a whirlwind turn of events, the US Fifth Circuit Court of Appeals has ruled that the Treasury Department's Office of Foreign Assets Control (OFAC) blew past their authority by sanctioning Tornado Cash, a set of decentralised software known as a "crypto mixer" which permits users to have privacy in their transactions by mixing multiple transactions together (but paying out the correct amounts to each person entering the mixer). This appeal court decision overturns the lower court's ruling and has been hailed as a “historic win” for the crypto industry by Coinbase’s Chief Legal Officer, Paul Grewal.
At the heart of the case is a critical distinction: Tornado Cash is not a legal entity but rather is a collection of smart contracts powered by blockchain technology - self-executing lines of code which perform a function designed to enhance privacy. There is no central party who can turn the code on or off. The lower court decision determined that the software contract address for Tornado Cash could be sanctioned and that it was "property" which could be the subject of sanctions. The appeals court has disagreed, saying these smart contracts cannot be classified as “property” under US sanctions laws such as the International Emergency Economic Powers Act (IEEPA). The court emphasised that OFAC exceeded its mandate, as the smart contract code itself cannot be owned or blocked.
The clouds of this case gathered in August 2022 when OFAC sanctioned Tornado Cash's smart contract address, alleging that the Tornado Cash mixer had been used by North Korea’s nuclear weapons program and notorious hacking group Lazarus Group. The sanctions designation sparked a lawsuit from various plaintiffs, including Tornado Cash users, who argued that the sanctions infringed on their rights to privacy and improperly inflated the definition of "property" under US law to high altitude. The appeals court has now agreed, holding that Tornado Cash's open source smart contracts are "immutable smart contracts" and not capable of being owned.
The Court went on to find that the smart contracts were not in fact contracts at all, being in the nature of a unilateral contract, there being no operator of the code in this case. The Court indicated that its analysis might be different if the smart contracts were in fact mutable (e.g. upgradeable) and otherwise controllable or custodial.
The Court observed the Tornado Cash contracts remain available to users to fill their sails with privacy and navigate an otherwise transparent public blockchain network with that benefit. This issue was raised in the earlier decision, as open source smart contracts cannot be taken down without co-operation from a majority of nodes in a blockchain network, and with those nodes geographically disbursed and relatively easy to set-up, a near impossibility.
On the basis of this ruling, the Appeals Court observed that it was not necessary to go on to consider whether Tornado Cash was an entity or capable of holding an interest in the immutable smart contracts, themselves not being capable of being property.
After the ruling, Tornado Cash’s governance token, TORN, surged dramatically, with the token up ~500% in the last 24 hours at the time of writing.
Source: CoinGecko
While this fresh breeze of judicial clarity is welcome for blockchain enthusiasts and innovators more used to the doldrums of regulation by enforcement, it is important for businesses and developers to keep a clear eye on the regulatory horizon. Tools like Tornado Cash, like any tool for privacy, can be used for good - ensuring financial privacy in a world of increasing surveillance - but also can be used by criminals for nefarious purposes. Striking the right balance between innovation and accountability is crucial to weathering any storms and charting a course to a clearer day.
Meanwhile, persons involved in the development of mixing services have been the subject of a wave of prosecutions by US regulators. The developers of Tornado Cash themselves have been prosecuted in the United States and the Netherlands. Some experts have speculated that the Appeals Court decision may prompt Congress to act to introduce tougher restrictions on the development of these types of services.
For now, Tornado Cash and the list of designated smart contracts remains on OFAC's Specially Designated Nationals List. It remains to be seen if OFAC will now take steps to remove Tornado Cash entirely or perhaps only the list of immutable smart contracts from the designation upon the matter being remitted to the lower court to enter judgment. Of course, OFAC may yet seek to appeal to the US Supreme Court.
With a new US administration set to take over in January, this case underscores the need for clear and fit for purpose laws that foster innovation while mitigating harm appropriately.
Written by Steven Pettigrove, Luke Higgins and Michael Bacina
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