Decentralisation post Tornado cash
Last week, the US Treasury’s Office of Foreign Assets Control (OFAC) added Tornado Cash and its associated crypto wallet addresses to the Specially Designated Nationals (SDN). This means that any person interacting with these wallet addresses could now face criminal penalties.
The Implications
This regulatory move will have significant implications in the short and long term for decentralized protocols. Let us analyze the impact on key stakeholders:
The Tug Of War
The community is currently questioning, will there be an alternative framework that evolves to follow the ethos of decentralization and still complies with the wishes of authorities? If protocols start accepting rules passed by one country, what happens when other countries follow suit? How would decentralized protocols survive in the future, and how would they navigate the regulatory landscape?
Furthermore, the folks who support democracy and the western notion of freedom of speech notice that “Tor” is serving folks in countries which does not aspire to the higher ideals - and unceremoniously blocks them. So what happens if North Korea starts using Tor - will the US ban it?
What really would be the legal reasoning for the action of adding entities to the SDN list? Also, one should be closely monitoring what happens with Zcash, Monero, and the list of privacy coins, given this is what has happened to Tornado.
Potential Solutions
A promising solution is a KYC-ed entry to privacy-providing mechanisms such as shielded pools. This could be enhanced by disclosure schemes as well. This way it would be possible for anyone who wants to have privacy to have verified credentials and be subject to KYC/AML requirements.
It is possible for users of privacy protocols to prove in zero-knowledge that they are compliant with KYC/AML requirements and then enter a protocol that provides them with privacy for transactions in deFi. The option to do selective disclosure allows any of the users of the protocol to prove to authorities that a given set of transactions have originated from them. This has been the approach that Panther Protocol has been aiming at from start and might be able to meet the requirements of SDN opt-outs without having to go to great lengths.
Closing Thoughts
On a more political note, some of the actions in regulation are driven by the actions of nation-states. In the case of Tornado Cash, the US government is claiming that it hopes to block North Korea from converting funds into more usable currencies to fund weapons proliferation. However, the follow-on effect on retail users will be harsh. By preventing privacy-providing mechanisms one might wonder if regulators are truly thinking long term.
Imagine a country that has a “firewall” that isolates itself from the rest of the world, let's assume this exists even in the blockchain world. If this country ever enters into a war or even a low-intensity hostility it would have an advantage over nation states which has no privacy, as no one outside of its “firewall” could see the transactions happening. The need for an economic intelligence unit in such a country is greatly reduced given all democracies' citizens have no rights to financial privacy and their transactions are all publicity visible. So this might end up being a disadvantage in the long run, and who knows what the long-term second-order effects are…