On November 26, 2024, the U.S. Court of Appeals for the Fifth Circuit ruled that the U.S. Treasury Department’s OFAC sanctions against Tornado Cash were unlawful and exceeded its own statutory authority. As Coinbase CEO Paul said: "This is a historic victory for the encryption industry and everyone who cares about defending freedom."

No People want criminals to use encryption protocols, but the laws enacted by Congress do not empower regulators to completely block entire technology-neutral open source code because some users do evil. Regulatory enforcement that exceeds authority needs to be limited.

The court of second instance clarified that although OFAC does have legal reasons to prohibit illegal activities, Tornado Cash serves as an immutable smart contract (a line of software code that supports privacy) are not “property” of a foreign country or entity, meaning (1) they cannot be blocked under the law and (2) OFAC exceeds its statutory authority granted by Congress.

This referee has epoch-making significance for the encryption industry. It not only clarifies the definition of immutable smart contracts, but also provides guidance for those facing the global complex regulatory environment. The crypto industry provides guidance and direction.

Therefore, this article analyzes the significance of the Tornado Cash case from the perspective of a Web3 legal practitioner, and looks at the source of OFAC’s regulatory and enforcement power, which cannot be changed ( Immutable) smart contract definition, and the future development trend of decentralized networks.

1. What is Tornado Cash

Tornado Cash is a well-known currency mixing application on Ethereum. It aims to provide users with transaction privacy protection by confusing digital currencies. The source, destination and counterparty of the transaction, thereby achieving private and anonymous transactions.

Tornado Cash accepts transactions (user deposits) of different types of tokens. The smart contract combines various types of tokens through the application of Zero Knowledge Proof technology. The transactions are mixed together, thereby cutting off the public link between the deposit address and the withdrawal address, and then transmitted to the counterparty (user withdrawal), achieving transaction privacy, and users no longer have to worry about their transactions being monitored on the chain.

Tornado Cash coin-mixing smart contract provides two valuable features: Privacy (anonymous digital transactions) and Immutability (because the software code cannot be owned, controlled and changed - even its creation cannot be changed)

Although the wallet on the chain is anonymous, the transactions between wallets are traceable and permanently recorded on the blockchain. Interested people can use some technical means to compare the transaction records of the wallet with individuals in the real world. Correspondingly, this is very scary. Tornado Cash can precisely solve this pain point and interrupt the transaction track between wallets, thereby protecting the privacy of the users behind the wallet.

(Tornado Cash Case)

2. The background of Tornado Cash being sanctioned

Tornado Cash is an innovative application of neutral technology. It can help legitimate users provide transaction privacy protection, but it cannot prevent malicious users from illegal uses, such as it being used in money laundering crimes in reality.

August 8, 2022, Tornado Cash Sanctioned by OFAC, the U.S. Treasury Department’s Office of Foreign Assets Control, the Tornado Cash protocol, 37 Tornado Cash smart contracts (including at least 20 immutable smart contracts), and an address used to accept donations were designated as “entities” and included in the sanctions list, citing North Korean hacking groups using Tornado Cash to commit cybercrime, such as money laundering.

Three months later, OFAC issued new guidance that included sanctions on 53 Ethereum addresses associated with the Tornado Cash protocol. The guidelines identify Tornado Cash as an entity operated by its DAO organization and thereby block "all real, personal and other property and interests in property" of Tornado Cash entities subject to U.S. jurisdiction.

By adding Tornado Cash to the Specially Designated and Blocked Persons (SDN) list, OFAC imposes a blanket ban on any "property" related to Tornado Cashtrade. Among them, OFAC defines it as including open source computer code called "smart contracts."

In other words, it is illegal for any entity or individual to interact with the on-chain addresses in the SDN list. In a press release at the time, OFAC stated that since 2019, the amount of money laundered using Tornado Cash has exceeded US$7 billion. Tornado Cash has provided material assistance, sponsorship, or financial and technical support for illegal network activities in the United States and abroad. These actions may pose a major threat to the security, diplomacy, economic health, and financial stability of the United States, and are therefore subject to sanctions by OFAC.

3. The first-instance judge ruled that OFAC’s authority was legal

Six Tornado Cash users funded by Coinbase sued OFAC in the first-instance case. Their main theory was also the only one in the first-instance case. The theory supported on appeal—that OFAC violated the U.S. Administrative Procedure Act—that OFAC did not have the authority to place Tornado Cash on the sanctions list because (1) Tornado Cash was not a foreign " " or "person"; (2) Immutable smart contracts are not "property", (3) Tornado Cash cannot have property "interests" in immutable smart contracts.

The court of first instance rejected the motion of the Tornado Cash user, concluding that: (1) Tornado Cash is an "entity" that can be designated as an individual under the law, ( 2) Smart contracts constitute "property", (3) and the DAO operating Tornado Cash has an "interest" in its smart contracts because it derives profits from the services running on the smart contracts.

This referee caused huge controversy in the industry, especially regarding the characterization of "Smart Contract", a product under the technology-neutral background, and It has caused the industry to think about Web3 privacy and financial supervision. Once software code such as smart contracts is defined as "property," it means that it may violate citizens' rights to free speech and personal privacy under the First Amendment of the U.S. Constitution.

Fortunately, the recent second-instance referee gave us a clear answer and a bright future for the development of decentralized networks.

(From the Tornado Cash incident, look at the regulatory logic of OFAC on Crypto in the United States)

4. The second-instance judgment clarified the definition of an unchangeable smart contract

On November 26, 2024, the second-instance court overturned the first-instance court’s judgment in the appeal case ——OFAC The sanctions are illegal and exceed its legal authority.

The focus of the case is: an open-source, crypto transaction software protocol like Tornado Cash , whether it is "property" and "interests" under OFAC supervision.

If the answer is no, then OFAC does not have the authority to impose sanctions against Tornado Cash.

OFAC's regulatory enforcement powers come from: the International Emergency Economic Powers Act and the North Korea Sanctions and Enhancement Act, which give the president the power to regulate (or block) Property in which a foreign " " or "person" (or "entity") has an "interest".

The International Emergency Economic Powers Act is an integral part of the modern U.S. sanctions regime, which authorizes the president to freeze any goods deemed to pose a threat to U.S. security. assets of foreign actors and prohibiting transactions with them. This broad authority is administered by the Treasury Department’s OFAC, which oversees various economic sanctions programs.

OFAC promulgates regulations through these authorities, including regulations on "person", "entity", "property" and "interests". (interest)" and other definitional provisions. It also provides an avenue for people affected by a blockade designation to challenge it and sometimes grants permission to engage in transactions involving blocked property.

4.1 Immutable smart contracts

The judge distinguished smart contracts in the ruling document to avoid confusing all smart contracts in the first-instance ruling. The misunderstanding of uniformly identifying it as "property".

Smart contracts can be divided into two types: (1) Immutable smart contracts, usually controlled by one or more subjects; (2) Immutable smart contracts, which no one can control Once a smart contract becomes immutable, no one can reclaim control over it.

corresponds to Tornado Cash, a decentralized, open source software protocol. As early as 2019 Initiated by a group of developers in 2020, although some smart contracts were changeable at the time, in 2020, developers launched a "trusted setting ceremony" to remove control of smart contracts. More than 1,100 users participated, and at least 20 smart contracts were irreversibly transformed into immutable smart contracts.

Thus, Tornado Cash becomes an automatically executed computer code that can no longer be changed, deleted or controlled. The software protocol is deployed on the blockchain and operates on its own without any human intervention. The entire smart contract and Tornado Cash network are governed by the DAO organization.

4.2 OFAC’s Basis for Sanctions

Although Tornado Cash is neutral, most users have good intentions, such as anonymously donating to the Ukrainian war to avoid hacker attacks. However, it is difficult for the protocol to restrict malicious users from laundering illegal proceeds through the Tornado Cash tool.

That's why OFAC steps in, under the International Emergency Economic Powers Act, which allows the president to "declare a state of emergency in response to" any "unusual and exceptional threat." "After exercising special economic powers, all or most of these threats originate outside the United States and pose a threat to the security, diplomacy or economy of the United States. This includes freezing any property in which any foreign country or a national thereof has any interest.

4.3 Tornado Cash is not property

Although the law gives the President the power to own an "interest" in a foreign " " or "person" (or "entity") "Rights" for supervision and enforcement. But the second instanceThe court did not accept that Immutable smart contracts can be classified as “property” and “interests”.

"Property" should be an asset that can be owned, with clear ownership and corresponding rights of disposal, exclusivity, etc.

Property has a plain meaning: It is capable of being owned. Property includes everything which is or may be the subject of ownership, whether a legal ownership, or whether beneficial, or a private ownership.

It is “the condition of being owned by or belonging to some person or persons” and encompasses “the right to possess, use , and dispose of something." It also includes the right" to exclude everyone else from interfering with it.”

In this case, Tornado Cash - an immutable smart contract, obviously cannot be owned by anyone, nor can it be owned by anyone. Exclude anyone from using it. We can see that even if Tornado Cash is sanctioned by OFAC, users can still call its underlying smart contract to use it.

"Those immutable smart contracts remain accessible to anyone with an internet connection."

4.4 Tornado Cash is not a contract or service

OFAC advocates that immutable smart contracts can constitute "rights and interests" related to "property", such as rights and interests in contracts.Rights and Interests of Services. However, the court of second instance made it clear that although the smart contract is called a Smart Contract, it is not a real contract (the smart contract is not itself a contract).

A contract is a mutual agreement between two or more parties and is revocable. Obviously, smart contracts are just software codes and cannot make offers, nor can they make revocation and other contractual rights that need to be exercised by the contract subject. Likewise, we cannot have an Immutable smart contract change its code, delete its code, or be removed from the Ethereum blockchain network. Smart contracts are simply interactions between users and software code.

Similarly, a service refers to "performing some useful action or series of actions for the benefit of others, usually for a fee." Here, a smart contract is just a piece of Computer code cannot be executed for the benefit of others, or to obtain benefits.

Tornado Cash smart contracts are tools used in providing a service and do not control these smart contracts (The immutable smart contracts are not property because they are not ownable, not contracts, and not services).

4.5 The second-instance court’s ruling

As a result, the second-instance court overturned the first-instance court’s ruling and determined that OFAC’s regulatory enforcement exceeded its statutory authority.

The court finally stated: We can see the real-world disadvantages of certain unregulated, uncontrollable technologies. Presidents and governments were rightfully concerned about malicious cyber activity, so IEEPA became law in 1977, years before the invention of the modern Internet.

However, the law only grants the presidential department broad powers to regulate various economic transactions, and its authority is not unlimited or expanded.

5. The victory of the decentralized network

Although this is only the ruling of the second instance court, OFAC has the right to advance the case to the Supreme Court, but we have already made the decision in the second instance. As seen in the document, there are strong requirements for immutable smart contracts.A powerful argument that is difficult to overturn.

As Coinabse said, On Chain is the New Online. As more and more decentralized protocols and networks reach thousands of households, the previous purely permissionless approach on the chain needs to be further improved and made legal and compliant. How to balance technological innovation and regulatory enforcement from a technology-neutral perspective is an important proposition that every legislator and regulator needs to discuss.

In any case, just as Grayscale’s successful case against the SEC paved the way for the passage of the BTC ETF, Tornado Cash’s case also paved the way for the adoption of decentralized networks. paved the way for further development.

As Emperor Putin said: Bitcoin and other electronic payment methods, as new technologies, cannot be completely banned, and they will continue to develop because They have advantages in reducing costs and improving transaction reliability.