A dangerous precedent was set when Circle banned users of the Tornado Cash cryptocurrency mixing service from trading USDC. This is a wake-up call for everyone; not just crypto and privacy-enthusiasts.

Much is being said of Tornado Cash’s usage by the North Korean state-backed hacking group Lazarus, but the likelihood that North Korean hackers make up anything more than a tiny fraction of a percent of Tornado’s users is small.

What’s really going on is that Circle, the company issuing USDC, is reacting directly to the wants of the US government. The U.S. Treasury Department has added all Ethereum wallet addresses associated with Tornado Cash to its list of Specially Designated Nationals And Blocked Persons List (SDN). This has effectively made Tornado Cash illegal in the U.S., putting it on the same level of classification as terrorist organizations.

The fact that blacklist capability can be written into the token contracts is a huge point of coercion for the state. On the Bitcoin network, individual nodes can blacklist a Bitcoin address, but they risk forking themselves from the network if they don't have the 51% of hash power required to enforce it.

With an Ethereum smart contract, tokens in a blacklisted address cannot be moved. Right now, any user that has ever sent funds to the newly-banned Tornado Cash smart contract finds themselves locked out of their USDC - possibly forever. 

From day one, there was a warning about what could happen if this feature was added to the USDC contract. Now we have a centralized company at the mercy of U.S. regulation running the fourth largest cryptocurrency in the world - and over $55 billion of market cap is on the line.

Imagine a private company having full control over all your wealth. What if they decide to privately sanction certain countries? 

For the most part Tornado Cash was used legally and fairly. There are innocent users caught up in this that have used Tornado for totally legitimate privacy reasons.

You can bet that governments around the world will require blacklist capability on tokens now that USDC is proving it is viable. The US Internal Revenue Service (IRS) is hiring 87,000 enforcement agents as the Fed is sanctioning privacy-preserving technology - where do we think this is all leading?

Can’t we use that headcount and the $80 billion the US government has just set aside for IRS enforcement to track the Lazarus wallets and actually sanction the bad guys, rather than just anyone associated with a single provider? 

If the Department of Justice (DOJ) with Bitfinex can track down the hackers that stole 119,000 Bitcoin from the platform in 2016, tracking a handful of wallets using a relatively niche service should not be that difficult.

Ultimately, this is likely the first move that will see the US government more widely enforcing its 2019 FinCEN guidance. Under this rule, they can sanction decentralized finance applications in the same way they can sanction traditional financial institutions. 

All of this comes at a time when the US is becoming keenly aware of the threat cryptocurrencies pose to the dominance of the US dollar as the world’s reserve currency. Wait until the EU, China and other governments start enforcing the FATF guidelines. It seems governments and financial incumbents are beginning to feel the heat of competition and draconian clampdowns are their answer.

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