Tornado Cash And The Problem of Bitcoin Mixers

On 8 August 2022, the Office of Foreign Assets Control of the U.S. Department of Treasury blacklisted Tornado Cash. The rationale, according to the department, was simple; Tornado Cash was running an illegal crypto service that made it easy for criminals to launder money. The blacklisting of the service made it illegal for any resident or citizen of the United States to send or receive money through the service.

That same day, the domain used to host the project was taken down, and GitHub suspended the developer's accounts. Web3 companies were not left out of the loop either, as Circle, the second biggest issuer of stablecoins froze about $75,000 in USDC from Ethereum addresses belonging to Tornado Cash.

However, the feds were not only going after Tornado Cash as an entity. They were also going after the builders of the protocol. Two days after it was blacklisted, Alexey Pertsev, one of the founders of the protocol, was arrested and detained in Amsterdam. He's yet to be out.

With that, the Department of Treasury had effectively taken down Tornado Cash in almost its entirety. However, the question remains; why? What made Tornado Cash so dangerous that the federal government deployed everything they had to bring it down?

The Mixing Conundrum

When people talk about the benefits of Bitcoin as a currency and indeed Crypto as a financial system, they never fail to mention anonymity. Bitcoin, they often say, is great because it offers anonymity, which is something traditional banking doesn't offer by design. However, that isn't entirely true. For example, if you hold your coins in a centralized exchange, you have very little anonymity.

Even if you hold your coin in your address, on-chain analysis could help snoopy third parties either link the address to your real-world Identity or trace what you're doing with your funds.

For people who require complete financial privacy, this would simply not do. Since the world of cryptocurrency is probably the closest approximation of a free market anyone can find, it wasn't long before this problem was solved.

The solution to the pseudonymous problem of crypto was something called Bitcoin mixing. Bitcoin mixing is a service that mixes tainted or potentially tainted crypto tokens with others, to make it difficult to track down the coin's whereabouts. This is usually done by pooling funds from diverse sources together and then dispersing them at random at different intervals. It makes it very difficult for even the most motivated third party to track the funds and hereby taint it. Since both legal and illegal actors can use Bitcoin mixing services, it's near impossible to taint any crypto that originates from the mixing address.

This gives law enforcement a huge headache. Before the popularity of these mixing services, law enforcement could trace laundered or stolen crypto funds with a great degree of accuracy. In fact, they could make it so that no other reputable organization makes transactions with tainted addresses or crypto.

Bitcoin mixers throw a spanner in that wheel and make that idea completely untenable. It's easy, as a crypto maximalist, to argue that the government is wrong to be against these mixers. However, the facts paint a more nuanced picture.

In 2013, in the wake of the robbery of Sheep Marketplace, Bitcoin fog, a mixer, was used to launder some of the 96,000 stolen bitcoins. Two years later, Bitcoin fog was also used to launder a total of 7,170 Bitcoin stolen from Chinese exchange Bter.com. From 2014 to 2017, an Ohio man named Larry Dean Harmon laundered around $300 million in stolen coins through his Bitcoin mixing service Helix.

In other words, it's clear that these mixers are being used for illegal transactions, and the government is correct to be interested in them.

Tornado Cash's Tornado

The US government has been on the trail of Bitcoin mixers for a long while. Bitcoin blender, one of the biggest bitcoin mixers, closed down after it was hounded by law enforcement forces. Last year, Roman Sterlingov, the founder of Bitcoin Fog, was arrested by US forces on charges of money laundering. Early this year, US forces also went after the Russian darknet site Hydra and were able to close its servers and sanction the site itself.

One of the biggest Bitcoin mixing services in the world, Blender.io also got its share of sanctions after The U.S. Treasury Department's Office of Foreign Assets Control issued sanctions against it in May. According to the Treasury Department, the service had links to North Korea and hosted at least $21 million of the $622 million in the Axie Infinity hack.

These arrests made it clear that the government was increasing its surveillance of the crypto space, and was hell-bent on making it difficult for criminals to launder stolen funds.

However, Tornado Cash's present troubles are not just because it is a Bitcoin mixer. In other words, it wasn't targeted because it was just a run of the mill Bitcoin mixing service. There was something else.

In May 2022, there was an audacious hack on Ronin bridge — a blockchain project associated with the popular play-to-earn game Axie Infinity. The hack was linked to notorious North Korean cybercrime group Lazarus. Lazarus is infamous across cyberspace for planning and executing some of the most incredible hacks the cyber world has ever seen. The group made use of Tornado Cash to launder a huge chunk of the $622 million stolen by it earlier this year.

But that heist is just the biggest in a long string of incredible money laundering activities. According to law enforcement, Tornado Cash, since 2019, has been a willing tool used to launder over 7 billion in criminally acquired funds. After the explosion of DeFi in 2020, the service has picked up the pace in terms of running illicit funds and obfuscating their sources. According to analysis by TRM, over 40% of all the funds connected to the service in June and July of 2022 were illegal funds. Asides from that, the Lazarus group has used Tornado Cash to launder funds in all ten of its most recent heists.

Lazarus isn't Tornado Cash's only client either. The service was also used to launder funds stolen from the April 2022 Beanstalk hack where a hacker stole over $180 million of crypto. All of that money went through Tornado Cash. Even smaller criminals have made use of Tornado Cash's open source largesse. In 2021, the Bent Finance hackers and the Visor finance hackers moved around 350 ETH through Tornado Cash. In July, a hacker stole about 1,300 ETH from OMNI, an NFT money market platform, and immediately ran it through Tornado Cash to clean the money. Around the same period, cybercriminals sent $36 million in stolen funds from Harmony Protocol's Horizon bridge to the service.

These all show that Tornado Cash, at least in the eyes of law enforcement, wasn't just an innocent open source protocol anyone could use. It was a favorite tool for hackers and criminals, and they used it whenever they could and however they could. Like almost every Bitcoin mixing service, Tornado Cash has almost no guardrails to stop cybercriminals from using it. Despite public statements proposing KYC protocols, the service has continued to operate in the most laissez-faire manner. In retrospect, this meant that the service was always going to get sanctioned. It was completely Inevitable.

What Does This Mean For The Future Of Bitcoin Mixing

It's difficult to envision a future where law enforcement efforts are enough to stop Bitcoin mixing. While they can always take the big players out of the game, the fact that these services have no regulatory obligations and can be used for legal and illegal purposes means that they are going away no time soon.

Right now, it seems like the big players in crypto are content to disavow these mixers. Tether, for example, hasn't sanctioned any Ethereum addresses involved with Tornado Cash. However, the rationale for this is that the government is yet to ask it to do so and that it would do so immediately after they make the request. For crypto maximalists, this may be bad news as it means that crypto may be prone to state capture. However, one might argue that the threat that these hackers and services that help them pose to the cryptoverse is greater than the threat of state capture. If the Department of Treasury is right, hackers have made away with at least 7 billion dollars through the help of Tornado Cash in the last four years.

These are funds that could have helped countless innovations and may have helped build a more vibrant and safe crypto ecosystem. These are funds that may never be recovered.

While it's unlikely that Bitcoin mixing, and indeed Bitcoin mixers, go out of fashion by themselves, there's hope that they may eventually become obsolete. According to Chainalysis, the next few years may birth even more rigid fund tracing algorithms that may render Bitcoin mixing obsolete. If this happens, it would mean that crypto has taken its trash out, and solved the mixing conundrum once and for all.