How will the sued founder of Tornado Cash fight against the Federal Reserve?

How will Tornado Cash's sued founder battle the Federal Reserve?

Author: Aleks Gilbert, translation by: Shan Ouba, LianGuai

• Coin Center and Cravath lawyers say that the guidance from FinCEN may be a loophole that the founder of Tornado Cash can exploit.

• But some lawyers warn that this strategy may not be enough. FinCEN’s guidance is just guidance.

Last month, when US prosecutors charged two co-founders of Tornado Cash with money laundering, sanctions evasion, and operating an unlicensed money transmission business, a prominent law firm and a cryptocurrency think tank voluntarily presented a novel defense. This strategy was detailed in blog posts and legal commentaries and was welcomed by cryptocurrency lawyers, sparking hope in the industry that these charges would be seen as an attack on code writing and financial privacy.

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But concerns still remain.

Transaction Records

Bill Hughes, Global Head of Regulatory Affairs at ConsenSys and former Deputy Assistant Attorney General, commented on the prosecutors, saying, “Their actions may not necessarily be illegal.” “But it will certainly be a topic that the defendants will talk endlessly about.”

Blockchain is a public ledger where anyone, anywhere can view the entire transaction history of each wallet. Tornado Cash is one of several protocols built to address the lack of privacy issue, which has long been seen as an obstacle to adopting cryptocurrencies.

This protocol obscures the flow of cryptocurrencies on the blockchain, but has been embraced by cybercriminals, including the Lazarus Group, hackers linked to North Korea, and their development of nuclear missile programs.

Tornado Cash was sanctioned by the US Treasury Department in August 2022. Last month, federal prosecutors filed charges against 34-year-old co-founder Roman Storm and 35-year-old Roman Semenov.

Damian Williams, the US Attorney for the Southern District of New York, said in a statement, “Roman Storm and Roman Semenov are alleged to have operated Tornado Cash and knowingly facilitated money laundering activities.” “While publicly claiming to provide technologically advanced privacy services, Storm and Semenov were actually aware that they were helping hackers and fraudsters conceal the proceeds of crime.”

Released on Bail

According to Inner City Press, Storm had been living in Auburn, Washington and was released on $2 million bail after his arrest. On Wednesday, he pleaded not guilty in the Southern District of New York federal court. Russian citizen Semenov remains at large. The third co-founder, Alexey Pertsev, was arrested in the Netherlands in 2022 and is currently under house arrest awaiting trial. Pertsev will face a hearing on September 13th prior to the trial.

The cryptocurrency think tank Coin Center first emphasized the potential weaknesses in the prosecutor’s case in a blog post on August 23. Shortly thereafter, two partners from the New York law firm Cravath, Swaine and Moore represented similar cases. JPMorgan Chase and Robinhood were also involved.

The prosecutors claim that the co-founders and “others involved in the Tornado Cash service…engage in the business of transferring funds on behalf of the public.”

This would make Tornado Cash a remittance business that needs to register with the Financial Crimes Enforcement Network (FinCEN) of the Department of the Treasury and comply with requirements of the Bank Secrecy Act, screening users and monitoring transactions for illegal activities.

However, both Coin Center and Cravath lawyers argue that the guidance issued by FinCEN seems to indicate that Tornado Cash is not a money transmitter.

Therefore, Tornado Cash should not be subject to the Bank Secrecy Act, nor should it be required to screen potential users and monitor their transactions for illegal activities.

FinCEN wrote in its 2019 cryptocurrency guidance, “Anonymity software providers are not money transmitters.”

Cryptocurrency Wallets

Peter Van Valkenburgh, the research director at Coin Center, highlighted the clear contradictions in the government’s case.

In his blog post on August 23, Van Valkenburgh wrote, “The indictment presents various factual allegations, describing the activities in which the defendants engaged, but all of these facts suggest that the defendants fully comply with FinCEN’s guidance regarding anonymity software providers, rather than making them money transmitters.”

Cravath partners Benjamin Gruenstein and Evan Norris also made the same argument, citing different sections of the FinCEN guidance on cryptocurrency wallets.

“If the government is bound by FinCEN’s guidance, then how and whether it can prove that Tornado Cash exercises necessary and sufficient control over the funds, and thus founders conspired to make it a money transmitter,” they wrote in an article published on September 1 in the International Financial Crime Litigation Lawyer’s College.

Legal Mistakes

Cryptocurrency lawyers welcomed this argument on social media.

The Department of Justice’s indictment against Tornado Cash is legally flawed, according to cryptocurrency advocate and policy director of the Blockchain Association, Jake Chervinsky, who wrote on the website formerly known as Twitter.

Independent cryptocurrency lawyer Erich Dylus told DL News that the prosecutors “ignored” the charges against the co-founders by FinCEN. He added that the co-founders operating an unlicensed remittance business “contradicts the technical facts, and hopefully defense lawyers can refute this.” ConsenSys’ Hughes agreed that the prosecutors may not have taken sufficient steps to prove the charges.

“There will be… what I think is a strong legal argument for the defense, that the act of fund transfer never occurred,” he said. “The indictment itself raises serious questions about whether they have sufficient [evidence].”

The Power of Law

But of course, FINCEN’s argument is not necessarily the winner. “FINCEN’s guidance is just that, guidance,” Hughes told DL News. “It does not restrict the Department of Justice from taking a different view on two issues: one is the provision of the Bank Secrecy Act, and two is the provision of the actual regulations promulgated by FINCEN.” Kravas’ attorney also acknowledged this.

They wrote that the guidance “is not binding on FINCEN or the Department of Justice and does not have the force of law.” “However, it remains the best resource for understanding what these rules mean from the perspective of the agency that promulgated the definition of currency transfer in the context of digital assets.”

Delphi Labs General Counsel Gabriel Shapiro argued on Twitter that any defense citing FINCEN is “selecting” from the regulatory agency’s guidance. Shapiro believes that the section on “decentralized applications” is far less favorable for the defense. The guidance states, “When a DApp engages in money transmission, the definition of money transmission will be applicable to the DApp, the DApp’s owner/operator, or both.” Shapiro says the government could still lose.

“But in commenting on and addressing all of these issues, we must analyze/rebut the government’s strongest case,” he wrote, “not the case of a weakened opponent.”

Where Does Decentralized Finance Go From Here?

Dylus said that regardless of the validity of the government’s arguments, the indictment could cause trouble for other DeFi founders.

Anyone operating a DeFi user interface as a business without limiting Americans or sanctioned individuals is taking on some risk. This is a huge loss for American privacy and peer-to-peer technological innovation. Chicago attorney Carl Volz, who advises crypto companies, said DeFi founders can rest easy as long as their protocols are not welcoming individuals and entities on the U.S. sanctions list.

I think the issue with Tornado Cash is a national security issue, and that’s what prompted the government to take action. You may not see this situation on Uniswap or many other decentralized exchanges. Hughes said the prosecutors are likely aware that their case doesn’t align with FINCEN’s guidance.

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