Tornado cash and the effects of the sanctions: a breakdown

This March, the United States finance Ministry of Finance announced its decision to lift the sanctions imposed against Tornado Cash. Tornado Cash is a cryptocurrency mixing platform that is suspected of facilitating money laundering activities for actors of cyber threats.

This development is followed by a significant judgment of November 26, 2024, when the United States Court of Appeal found for the fifth court district that the Office for Contribution of Finance Ministry (OFAC) of the Ministry Had crossed sanctions against the crypto mixing service. The court came to the conclusion that autonomous software that cannot be changed or controlled by humans does not correspond to the legal definition of “property” according to the applicable federal laws and therefore cannot be sanctioned.

What is Tornado Cash?

Tornado Cash is a digital data protection instrument that was developed to disguise transaction paths in cryptocurrencies. As a decentralized software protocol, it enables Ethereum users to carry out transactions with increased anonymity by canceling the direct connection between the walls of the transmitters and recipients. The platform was introduced by an anonymous development team in 2019 and works with sophisticated Smart-Contract-Mechanisms. Users can deposit cryptocurrencies into certain digital pools, each provided for different transaction volumes. When depositing funds, the participants receive a cryptographic key with which they can later withdraw a corresponding amount from the pool at a later date, which effectively obscures the origin of the original transaction.

The anonymity of the platform is based on a decisive principle: the more participants use the service at the same time, the more difficult it becomes to track individual transactions. This approach creates a complex network of financial movements that presents the traditional methods of transaction tracking with a major challenge. Initially, the developers kept a certain control over the smart contract infrastructure. In 2020, however, they made the decisive decision to remove the possibility of changing the contracts and convert them into unchangeable, self-management code parts that work regardless of human interventions. The service is essentially based on a simple but effective premise: the mixing of cryptocurrency funds in several anonymous pools creates a robust mechanism for financial privacy in the digital ecosystem.

Hard US sanctions

The United States use sanctions as an effective foreign policy instrument to influence international behavior and to protect national security interests. These economic restrictions extend beyond the borders of the United States and aim at facilities and individuals worldwide through extensive financial restrictions. The reach of this policy is intended to deter the creation of far -reaching economic isolation of interactions with certain parties. The Office of Foreign Assets Control (OFAC) of the Ministry of Finance is the main executive of these strategic economic measures. In the past, the authority has focused on combating threats from terrorist organizations, drug trade networks and other facilities that are considered harmful to the national interests of the United States.

In a significant step, the OFAC took unprecedented measures against a cryptocurrency service on August 8, 2022. The authority claimed that the Tornado-Cash platform had made a significant contribution to enabling massive financial transactions with questionable origin, and in particular emphasized its potential role in supporting international networks for cybercrime. By recording the cryptocurrency service in the SDN list (Specialy Designated National and Blocked Personal) Effectively all economic interactions with the platform. The term interpreted the digital infrastructure of the service as a material “property”, which is subject to comprehensive financial restrictions.

Effects of the sanctions on Tornado Cash

The sanctions against Tornado Cash led to uniform patterns on various cryptocurrency pool sizes on the platform. The transaction volume for both deposits and payments decreased significantly immediately after sanctions in all pools. The smallest pool with 0.1 ETH was least affected with about 120 less weekly transactions, while the pool with 1 ETH with about 275 weekly transactions recorded the greatest decline.

The pool with 100 ETH, which in the past made the majority of the value of the platform, showed a unique pattern. After an immediate loss of value as a result of the US sanctions, the pool recovered in 2023. The analysis of the transaction volume showed that smaller pools (0.1 and 1 ETH) again reached the level before the sanctions, while larger pools (10 and 100 ETH) showed more long-term effects, which may indicate a lower anonymity with higher value.

Despite initial mass withdrawals, the net deposits gradually stabilized and finally approached the previous level or overturned it. While the transaction frequency declined, the anonymity pools continued to grow, which indicates that the core functionality of Tornado Cash in the field of data protection remained essentially unaffected.

The user fold, measured by the clear addresses that interact with Tornado Cash, was significantly back after the sanctions. This decline in user activity can be explained by numerous measures. First, the most important tornado-cash websites were switched off and made inaccessible. These websites offered users the opportunity to interact directly with the Tornado-Cash Smart Treaty without having to go through other instances. Second, some centralized stock exchanges started to block transactions with sanctioned tornado-cash addresses.

Even the block builder (participants who are responsible for the creation of blocks on Ethereum) actively rule out Tornado-Cash transactions in blocks until August 2023. These developments illustrate Ethereum's susceptibility to potential censorship and show how different the actors of the ecosystem can influence transaction processing and accessibility.

Public criticism

The intervention of the US Ministry of Finance against Tornado Cash was a milestone in the area of ​​digital assets and marked the first case of sanctions that were directed against a fully decentralized cryptocurrency software infrastructure. Basically, Tornado Cash works as a complex arithmetical mechanism that is used on the Ethereum blockchain. The underlying Smart Contract architecture is equipped with robust unchangeability, which effectively prevent a single actor from changing or disassembling the core functionality of the platform after it implemented.

The regulatory measure triggered significant controversy in the cryptocurrency community. Both technology experts and data protection officers argued that the sanctions were too far to combat potential digital misconduct. They claimed that the punishment of software developers for the development of neutral technological tools creates a dangerous precedent that may violate innovations to suffocate and legitimate technologies to improve data protection.

Key message

The most recent court ruling with which the sanctions against Tornado Cash lifted the trust of developers and users could strengthen data protection-oriented crypto platforms. Ultimately, it could lead to more sophisticated and more differentiated technological developments in digital finance and thus accelerate innovations in data protection-promoting cryptocurrency tools.

In addition, the judgment will probably lead to a comprehensive re-evaluation of regulatory approaches for blockchain-based financial technologies. Regulatory authorities could be forced to develop sophisticated, targeted framework conditions that take into account the unique features of decentralized financial systems. This could lead to a refined, context-sensitive approach in the supervision that recognizes the fundamental differences between the traditional financial infrastructure and blockchain-based platforms.