On Tuesday, the United States of America, through the Office of Foreign Assets Control placed a total ban on coin mixer Tornado Cash, preventing all "US Persons" from interacting with the protocol and using its services. This essentially rendered nearly $500million in total user deposits on Tornado worthless and irredeemable.
In terms of scale and value, this is an unprecedented move; a ban on a decentralized non-custodial protocol with such a high TVL (total value locked). This move shows that regulation can and will target DeFi (decentralized finance) if need be, and there may be far-reaching consequences of such a move in Africa, especially because tokens like stablecoins becoming popular means of inflation hedges.
Background on Tornado Cash
Tornado Cash is a Crypto asset mixer designed to obscure trails of crypto funds by blending users’ tokens with a pool of other individuals’ assets on the protocol. Tornado breaks the link between the sender and receiver's addresses on transactions sent to Ethereum, deploying smart contracts that allow users to deposit an ERC-20 token to one address and enable withdrawal from another address.
It goes beyond traditional crypto platforms in further concealing the identity of the people involved in transactions. While Tornado Cash is used by some people as a legitimate means to protect their privacy, regulators say it fosters illicit activity, including “facilitation of heists, ransomware schemes, fraud, and other cybercrimes”.
Public blockchains like Ethereum are notorious for their openness and transparency; all wallet transaction data and history is available online for all to see. So it makes sense for certain users to want to conduct private transactions without revealing their wallet balance or transaction history to the whole world. In that way, coin mixers like Tornado Cash are very useful for that.
But this anonymity can also be used for illicit transactions such as money laundering and transferring illicitly obtained funds. Hackers who have stolen funds will not want their activity traced so they resort to crypto mixers like Tornado Cash.
Tornado has been used in some high-profile crypto heists this year, including the $615 million theft of tokens from the Ronin network and a $100 million attack on Harmony protocol bridge.
Blockchain analytics firm Elliptic claims at least $1.5 billion in proceeds from crimes such as ransomware, hacks and fraud have been laundered through Tornado Cash, and that the entirety of the $100 million stolen from the Harmony bridge in June was laundered through the service
The OFAC ban on Tornado Cash
One of the largest crypto markets in the world, the US officially banned transactions on TornadoCash. This means that any “persons” in the US who initiate any transaction on Tornado after the ban are liable to imprisonment over breach of “OFAC” regulations.
OFAC is the Office of Foreign Assets Control in the US. They administer and enforce sanctions against high-profile individuals including major international terrorists, drug trafficking kingpins, and the financial/political elite of certain countries deemed hostile to American interests. Tornado Cash and all the Ethereum wallet addresses associated with Tornado Cash and its smart contracts were subsequently added to OFAC’s SDN List.
Blocking immediately imposes an across-the-board prohibition against transfers or dealings of any kind with regard to the Tornado Cash property. This imposes an obligation on all blockchains and token issuers (Bitcoin, Ethereum, USDT, USDC, WBTC etc) to prevent anyone from moving or redeeming these assets.
This means if I have 10eth, 15 USDC, 10 USDT and 15 BTC, the OFAC ban has rendered these tokens useless because they are blacklisted; the smart contracts in Tornado Cash have been blocked, so the “Transaction” function cannot work; you will not be able to redeem or trade any tokens for your crypto assets in tornado cash as at the time the OFAC directive was announced
If you are a US person, any interaction with Tornado Cash is probably illegal - including Gitcoin donations, working for the project, running or downloading its software, visiting its website, and depositing/withdrawing from smart contracts.
All assets in Tornado as of August 8th 2022 are tainted. Tether (USDT), Circle (USDT), BitGo (WBTC) and other coin issuers will refuse to redeem these tokens.
Can this ban realistically be enforced?
This is very uncertain. USDC, one of the largest stablecoins in the world, has already blacklisted all smart contract tokens on Tornado, and we should expect to see more of that soon enough. All tokens can be blacklisted at contract level.
But there’s no single person or entity behind the use of Tornado Cash, it is an open-source tool. You cannot effectively sanction a tool that is neutral in character and that can be put to good or bad uses like any other technology. What happens when a tornado user maliciously sends tainted assets to another person’s wallet and the assets in that wallet are blacklisted? Would that not be overstepping the breath of regulations?
In a weird twist of events, as the above shows, an anonymous user started sending tainted Tornado tokens to well-known crypto addresses including celebs like Jimmy Fallon and Shaquille O'Neal. Will these addresses be blacklisted too?
What happens in the scenario where Decentralized Exchanges (Dexes) investors find a way to withdraw from Tornado and dump the tainted assets into liquidity pools such as Uniswap. They can then be able to swap out of the pools, leaving remaining liquidity providers holding worthless assets which cannot be redeemed because the smart contract function has blocked them. By the time they realize this, it might be too late.
They may want to withdraw from Tornado Cash and withdraw to a centralized exchange (Cex), which may complicate issues in these exchanges and may lead to token issuers blacklisting all assets in the exchange altogether. What happens to the innocent investors in the exchange? Luckily the transaction can be blocked and the account blocklisted because CEXes use tools Chainalysis to track such transactions from Tornado.
Basically, either way, there will be people that will be left holding worthless tokens.
Crypto is growing in Africa- such a move will have devastating micro and macro effects
According to Chainalysis, crypto transaction volumes in Africa have grown by 1,200% between July 2020 and 2021. This is more prevalent in countries like Nigeria, Africa’s largest economy, with a reported one in three people having already reported using crypto, making it one of the largest crypto markets by users worldwide.
Nowhere is this more apparent than Nigeria, whose central bank barred its financial institutions from enabling cryptocurrency transactions last year, joining 23 other African countries that have either implicit or total bans on trading (Africa accounts for more than half of countries that restrict the purchase of cryptocurrencies.
In 2021, Kenya was ranked top globally in terms of peer-to-peer crypto trade, while Nigeria saw a meteoric rise in crypto use despite a ban. In Africa, the rapid adoption rates are being fueled by a young population that views virtual currencies as a safer counterbalance to their over-inflated fiat currencies.
Since the ban on Nigerian banks from enabling cryptocurrency transactions, bitcoin remains an actively traded asset in the country, partly due to the presence of platforms that enable peer-to-peer transfers.
The value of bitcoin traded on LocalBitcoins and Paxful—two platforms that match crypto sellers with buyers—grew from $32 million in January and February this year to more than $44 million in August. Most of that has been on Paxful, which has 1.5 million users in Nigeria out of its global base of 7 million users.
Many emerging markets will be watching closely as the US and EU move to regulate the crypto industry, and with China and Russia already taking a hostile stance towards the industry, the road looks murky for African investors.
There is some willingness of frontrunner countries like South Africa and Mauritius to demonstrate a progressive stance toward cryptocurrency, with the Central African Republic even going so far as to adopt Bitcoin as legal tender. Yet, there is still no general consensus on the attitude to crypto among regulators in Africa, and it is still usually one of ambivalence or animosity.
What are the prospects for African investors?
It is certain that crypto adoption will continue to grow; stablecoins are an important hedge against inflation and dwindling currencies, and crypto assets are seen as attractive investment opportunities and a way to grow a valuable portfolio in a short amount of time.
Although we have already seen countries like Nigeria "banning" crypto, this has mostly meant prohibiting banks from redeeming deposits and withdrawals from crypto exchanges. Even then, a lot of exchanges have found various innovative ways to circumvent these hurdles. In fact, as indicated above, crypto adoption is still growing in Nigeria despite the ostensible “ban”.
But the OFAC directive is unprecedented; the US is willing to use its highest level of economic sanctions usually reserved for foreign powers and extremely dangerous people against a privacy product in crypto. This is very unprecedented.
People have resorted to stablecoins and decentralized exchanges and protocols to circumvent regulation and oversight because of how hard it is to block out Dexes.., but now with such a ban, it goes to the very core of the blockchain industry; the smart contract level.
Tokens can be blocked at the smart contract level, and that is it. They are worthless and cannot be redeemed. Such a move by African regulators would have profound effects on not only primary investors in decentralized protocols, but also a domino effect on investors in centralized exchanges. Cexes are notorious for “degen trading” on decentralized exchanges with user funds (even though many would deny it), so moves targeting these protocols will certainly affect all types of crypto investors; wherever the funds are stored.
These are certainly unprecedented times in crypto and we may be seeing more of these types of regulatory oversight as the industry gets bigger.