U.S. Treasury Department releases Tornado Cash guidance

New guidance from the U.S. Treasury Department's Office of Foreign Assets Control provides a roadmap for people who used Tornado Cash for lawful transactions to withdraw their stuck funds.

Driving the news: On August 8, Treasury announced that the smart contracts that made up the Tornado Cash transaction privacy application on Ethereum had fallen under U.S. sanctions, meaning that no U.S. person could use it.

Why it matters: There is currently $200 million sitting in Tornado Cash's smart contracts now, according to DefiLlama, which is less than half of what was in there at the time the sanctions were announced.

• Much of that likely belongs to U.S. citizens or residents who are nervous about withdrawing funds and violating sanctions.

Background: To use Tornado Cash to mask the recipient of a transaction, a user would deposit it and get a code or token to withdraw it to another address later. The longer they waited, the harder it was to connect a withdrawal to a deposit.

• The more deposits there were, the harder it is to match them with withdrawals, so Tornado Cash rewarded people who let their deposits sit with its TORN token.
• Many people likely only deposited in order to earn TORN, which has traded between about $17 and $60 over the course of 2022.

State of play: Since the sanctions have been in place, the Tornado Cash website has come offline, but that simply provided a user-friendly way to access the application. The Tornado Cash app will continue to operate on the Ethereum blockchain as long as Ethereum exists, and users with some technical proficiency may continue to use it.

• One U.S.-based author promptly made two donations using Tornado Cash immediately afterward as an act of protest.

Details: The new guidance provides a way for users to lawfully withdraw their funds. They need to be prepared to give all the relevant information about their transaction to Treasury when they apply for a license.

• Immediately following the sanctions announcement, an anonymous user sent small amounts of ETH (known as "dusting") to numerous wallets (mostly belonging to celebrities). The guidance says that "OFAC will not prioritize enforcement" against these recipients.

• Of note: Treasury has policies around rejecting transactions from sanctioned entities, but Ethereum has no way to reject or block a transaction. So, if a person holds virtual currency from a sanctioned entity, they must deny other access to that currency, according to OFAC policy.

Yes, but: According to the new guidance, the sanctions don't forbid others from using Tornado Cash's code, discussing it or teaching others about it, so long as they don't interact with the sanctioned Ethereum addresses.

The intrigue: Three plaintiffs with funds in the application have sued the Treasury Department over the sanctions, arguing that it has stuck their lawfully deployed assets in legal limbo.

• The fact that there is now a means to withdraw those funds could change how the court views the case.

Flashback: Treasury previously attributed a $620 million theft of crypto assets set aside for the Web3 game Axie Infinity to North Korea's Lazarus Group, which is also on the sanctions list.

• At least part of those funds were laundered using Tornado Cash.