(Rachel Sun/CoinDesk)
Severe tensions have been unleashed in cryptoland since Ethereum-based mixing service Tornado Cash was added to the U.S. Office of Foreign Assets Control's (OFAC) specially designated nationals (SDN) list last week. But this is just the beginning.
The move, which was prompted by allegations of North Korean hackers using the service, could set regulators on a collision course with privacy-seeking crypto users and with developers of the tools they use. One can imagine an intensifying clash enveloping crypto natives and mainstream users alike.
That's because there are many reasons to expect a continued, growing demand for privacy – from an array of people far wider than the narrow subset of undesirables OFAC is aimed at. Let's start with one that's fundamental to currencies' role as a medium of exchange: fungibility.
It shouldn't matter which actual dollar you hold in your hand; it should be assigned the same value as any other dollar. A recipient can't care which explicit unit of a currency he or she is handed. If money isn't fungible like that, it can't function.
Privacy makes money money
Privacy is a prerequisite for fungibility. If distinct money units have a transparent, publicly known history, then there's a risk they will be valued differently. If a particular bitcoin or stablecoin was at some point flagged for passing through the hands of some SDN-listed person, company or software service, then people will discount its value or simply refuse to accept it. Goodbye fungibility.
Last week, entrepreneur Maya Zehavi pointed out how, following the OFAC announcement, providers of crypto services started using on-chain analysis to block not only wallets that transacted directly with Tornado Cash, but also second-hop and third-hop wallets further down the chain whose mix of tokens was "tainted" by that up-chain association. Differing histories were now making certain tokens less desirable than others as they were at risk of being blocked.
How might users protect themselves from unintended tainting? Zehavi argued they will have to obfuscate all transaction history leading to their wallet. How? With a non-banned mixing service.
So, we can see how banning one mixer can fuel even more demand for replacement services and incentivize developers to create them. We can also see how it might create an accelerating cycle of bans on mixers and new ones popping up to replace them. (It's worth noting, as a counterpoint, my colleague Dan Kuhn's argument that anyone seeking to clone Tornado Cash's open-source code has the difficult task of winning the community's trust and avoiding government crackdowns.)
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