The co-founder of Tornado Cash was found guilty. What is the impact on DeFi?

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How will DeFi coexist with regulation in the future?

Today, a Dutch judge ruled at the Court of ‘s-Hertogenbosch that Alexey Pertsev, one of the founders and core developer of Tornado Cash, was guilty of money laundering. The court sentenced Pertsev to 64 months in prison. Over the past year, the DeFi regulatory issues raised by Tornado Cash have been highly concerned by the industry. This year, despite the teams repeated emphasis on its compliance tendencies, Uniswap, the big brother in the DeFi field, was sued by the SEC. Today, what impact will the guilty verdict of Tornado Cashs co-founder have on future DeFi startup teams? How will DeFi coexist with regulation in the future?

Even if the team and the protocol are separated, will it still be difficult to escape DeFi regulation?

The Tornado Cash trial continues to serve as a wake-up call for other cryptocurrency services.

In April 2023, the U.S. Treasury Department released an assessment report on illegal financial activities in DeFi, which revealed the potential risks in DeFi services and deeply analyzed the criminal activities of illegal actors using these services. Three months later, four U.S. senators proposed the Crypto Asset National Security Enhancement and Enforcement Act, which also aims to strengthen supervision of KYC, AML and DeFi.

The Crypto-Asset National Security Enhancement and Enforcement Act provides a new framework for regulating DeFi, requiring that DeFi be regulated like other cryptocurrency institutions, requiring that anyone who can control the project must be responsible for the project. The bill may mention that if no specific person can control the DeFi service, then any investor who invests more than $250,000 in the project should be responsible for the project.

Related reading: The US courts friendly ruling on Uniswap, what does it mean for DeFi regulation?

In line with current regulatory hot spots, the focus surrounding Pertsev’s trial is whether laws aimed at curbing money laundering can adapt to blockchain-based financial innovations, anonymous transactions and other values.

In a hearing that Pertsev experienced in March, prosecutors argued that protocol developers did not do enough to prevent criminals from exploiting Tornado Cash. Pertsevs defense countered that prosecutors should consider the open source and automated nature of Tornado Cashs core smart contracts. It would be wrong to hold Pertsev responsible for Tornado Cash users, who are anonymous and independent by design.

Pertsevs defense attorney Keith Cheng said that no project can prevent users from using the open source smart contract code in any way they like. The contributors to the protocol are a decentralized organization with no single person in charge like a traditional company.

But prosecutors rejected such a view, arguing that the advantages of the technology outweighed the legal obligations to prevent the platform from helping criminals and sanctioned entities (such as the North Korean hacker group Lazarus Group) conceal the origin of stolen assets. Tornado Cash is not just a smart contract, it operates like a company, said prosecutor Martine Boerlage.

But perhaps considering the controversial nature of the case, Pertsevs trial in the Netherlands was very opaque, with prosecutors only disclosing his indictment a week before Pertsevs trial. The preliminary trial and a series of hearings were also conducted in Dutch.

Pertsev has won support from various parties, including petitions, fundraising for lawyers, and statements from hacked protocols declaring his innocence. The crypto community, especially the developer community, has strongly protested Pertsevs arrest, and they are worried that the charges against Pertsev could set a dangerous precedent for the conviction of software developers.

The co-founder of Tornado Cash was found guilty. What is the impact on DeFi?

Earlier, posters supporting Alexey Pertsev were distributed outside the Dutch court.

Previously, the U.S. Department of Justice and other regulatory agencies (DOJ) filed criminal charges against Tornado Cash founders Roman Storm and Roman Semenov, accusing them of conspiracy to launder money, violating sanctions regulations and operating an unlicensed remittance business during the operation of Tornado Cash. The two will face at least 20 years in prison.

Storm was arrested last year and will stand trial in September this year, while Semenov has not yet been arrested. The verdict of Pertsev is likely to determine the outcome of future trials for the two Tornado Cash founders.

After Tornado, Uniswap case becomes the focus

In fact, after Tornado Cash, many crypto protocol owners have been accused of criminal activities that occurred on them. For example, Uniswap was accused of allowing fraudulent tokens to be issued and traded on the protocol, and the lawsuit was eventually dismissed by the court in 2023.

At the end of last year, a16z wrote a comment letter for the Financial Stability Boards (FSB) theme event International Regulation of Crypto Asset Activities, which began by discussing the difference between DeFi and CeFi, and how the appropriate DeFi regulatory framework should regulate Web3 applications rather than Web3 protocols (regulating businesses, not software). The debate about where DeFi protocols and applications fit into the regulatory environment continues, but even so, most legal experts agree that any DeFi front end with a U.S. connection (broadly defined) must comply with U.S. sanctions laws.

On April 11 this year, the U.S. Securities and Exchange Commission (SEC) issued a warning to Uniswap Labs on Wednesday, planning to take enforcement action against the company. It is reported that the warning was issued in the form of a Wells Notice, which is a notice sent by the U.S. Securities and Exchange Commission to a company before initiating formal litigation, providing the company with a last chance to refute any allegations. At present, the specific nature of the SECs allegations against Uniswap Labs is unclear.

The market reacted very sensitively to the news. According to market data, affected by the news of SEC warning, the price of UNI fell from $14 to the current $9.58, a 24-hour plunge of more than 14%. During this period, the on-chain transaction volume of UNI tokens surged, even rushing to the top of the Dexscreener Ethereum token hot list.

Uniswap responded promptly. Uniswap founder Hayden Adams confirmed on social media that Uniswap Labs had received a warning from the SEC and published an open letter in response. In the letter, Hayden mentioned that the team believed that the products they provided were legal, and accused the SEC of not being committed to formulating clear and informed rules, but instead choosing to focus on attacking high-quality participants in the crypto field such as Uniswap and Coinbase, while letting bad guys like FTX slip away.

In addition, Hayden specifically emphasized in the letter that Uniswap is an Internet company located in the United States to demonstrate its long-term adherence to the compliance development path. At the same time, Hayden also mentioned that this battle with the SEC will last for several years and is ready to appeal to the Supreme Court.

Related reading: If someone is needed to promote crypto compliance, we are the best candidate - Open letter from the founder of Uniswap

After being sanctioned, it is still the largest cryptocurrency mixer

Tornado Cash is a privacy-preserving protocol that mixes 10 cryptocurrencies, with the most mixed asset being native ETH on the Ethereum mainnet. At its peak in July 2021, over $700 million of ETH was held in the Tornado Cash pool contract.

A week before Pertsev went on trial, an indictment shared by the court showed that between July 9, 2019 and August 10, 2022, Pertsev and one or more other persons developed a habit of money laundering in at least several countries, including the Netherlands, Russia, the United States or Dubai. The court believed that Pertsev should at least be suspected of the criminal roots of illegal transactions on the Tornado Cash platform.

The indictment lists nearly 40 transactions processed by Tornado Cash from different crypto platforms, totaling 535,809 ETH, including KuCoin and Liquid (the exchange acquired by FTX before its collapse in 2022). The largest amount, 175,100 ETH (about $585 million), came from Axie Infinitys Ronin network, involving the largest theft in cryptocurrency history at the time. The attacker was the notorious North Korean hacker group Lazarus.

In August 2022, Tornado Cash and related Ethereum addresses were included in the U.S. Specially Designated Nationals List (SDN List) by the U.S. Treasury Departments Office of Foreign Assets Control (OFAC). At the time, the U.S. Treasury Department claimed that Tornado Cash was a key tool of the North Korean hacker group Lazarus, which was responsible for the $625 million hack of Axie Infinity and other major cryptocurrency thefts.

According to analysis, as of early May 2022, Lazarus Group has transferred 37,000 Ethereum, or about $100 million, to Tornado Cash. Some experts said that the black money of official hackers of a certain country accounts for 20% of the balance held by Tornado Cash smart contracts.

Related reading: The most severe crypto sanctions in history: What happened to Tornado Cash

Tornado Cash has said in response to such accusations that despite many attempts, it has not been able to prevent the Lazarus Group from adding black money. After all, Tornado Cash itself is positioned to help users obfuscate their on-chain transaction history.

The crypto community also believes that developers have become political prisoners of the US government simply for writing code, and this sanction involves more than just an attack on cryptocurrencies. However, the sanctions did not have a shocking impact on the Tornado Cash project itself. In the following month, $77.35 million in assets were still transferred on the Ethereum mainnet through Tornado Cash.

Related reading: Demand remains huge, Tornado Cash remains the largest cryptocurrency mixer on Ethereum after being sanctioned

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ODAILY reminds readers to establish correct monetary and investment concepts, rationally view blockchain, and effectively improve risk awareness; We can actively report and report any illegal or criminal clues discovered to relevant departments.

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