The Mixer Dilemma: Protecting Privacy While Also Serving as a Shield for Criminal Activities

Source: Honecomb Tech

Mixers have always been a special use case in the cryptocurrency industry, emphasizing enhanced privacy services that allow users to eliminate most traces of transactions left on blockchain networks like Bitcoin and Ethereum. However, this functionality of mixers is often exploited by hackers and criminal organizations as a tool to erase money laundering traces, making them a regulatory obstacle.

On August 9, the U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC) announced sanctions against the mixer Tornado Cash, prohibiting U.S. entities and individuals from interacting with the application. Three months prior, the regulatory body also sanctioned the centralized mixer service Blender. These actions reveal the national regulatory determination to strengthen anti-money laundering efforts in the cryptocurrency asset industry.

In the cryptocurrency field, various mixer applications and privacy blockchains like Zcash have always been rooted in privacy protection. This is mainly due to the transparency of transactions on blockchains like Bitcoin and Ethereum, leading some crypto users to worry about becoming targets for hackers, social engineering scams, or even kidnappings due to identity exposure, thus creating a strong demand for privacy protection.

Between privacy protection and illicit money laundering, mixers and privacy-focused blockchains exhibit a double-edged sword characteristic. Industry insiders believe that privacy and anti-money laundering should not be opposing forces; regulatory bodies should strike a balance between privacy protection and crime reduction, which is precisely the area where cryptocurrency technology can realize its true potential.

U.S. Treasury Sanctions Mixer Tornado

The U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC) has ultimately taken action against the mixer Tornado Cash. The department added Tornado and 38 Ethereum addresses to the "Specially Designated Nationals" (SDN) list, prohibiting all U.S. individuals and entities from interacting with Tornado Cash and the designated 38 Ethereum wallet addresses.

This is the second sanction against a mixer application by U.S. regulators this year. In May, OFAC sanctioned the centralized mixer service Blender, noting that Blender had connections to North Korean hackers who used it to launder funds stolen from Axie Infinity. Additionally, Blender was involved in laundering funds for ransomware groups associated with Russia, such as Trickbot, Conti, Ryuk, Sodinokibi, and Gandcrab.

In the cryptocurrency asset field, mixers have always been a special use case, emphasizing enhanced privacy services that allow users to eliminate most traces of transactions left on blockchain networks like Bitcoin and Ethereum. Although mixers themselves are merely technical tools, an increasing amount of illicit funds are laundered through mixers, posing challenges for regulatory bodies in combating illegal finance.

Compared to Blender, the decentralized Tornado Cash is more well-known in the cryptocurrency industry and is used more frequently. The protocol operates on the Ethereum blockchain, achieving the goal of "mixing" by receiving various transactions and obfuscating the sources, destinations, and counterparties of crypto assets.

In the sanctions document, OFAC listed multiple offenses of Tornado, stating that since its creation in 2019, it has been used to launder over $7 billion worth of crypto assets, including over $455 million in crypto assets stolen by the North Korean hacker group Lazarus Group from Axie Infinity's Ronin Bridge, as well as funds stolen from Harmony Bridge in June and recently from Nomad Bridge.

Since Tornado is a decentralized application, it has open-sourced its smart contract code and opened its user interface code in early July. Theoretically, any developer can "revive" Tornado based on its open-source code or directly mix coins through the smart contract. Therefore, industry insiders believe that Tornado is unlikely to be completely shut down, as the smart contract code can run indefinitely without developer maintenance.

However, OFAC's heavy-handed action to "eliminate" Tornado has triggered a chain reaction.

After Tornado Cash was sanctioned, GitHub banned all accounts that had contributed code to Tornado, including the co-founder of the mixer protocol, Roman Semenov. Additionally, the Tornado code repository was removed from GitHub, and its official website is no longer accessible.

The mainstream stablecoin service provider USDC in the cryptocurrency industry also responded to the regulatory actions, blocking certain blockchain addresses that interacted with Tornado and freezing USDC in several transaction addresses.

Mixer Usage Reached Historic High in 2022

The consecutive sanctions against mixer applications by U.S. regulatory bodies indicate that they are strengthening anti-money laundering efforts in the cryptocurrency asset field. In the face of the long-term goal of combating illegal finance, the "privacy" emphasized by mixers has instead become an obstacle for regulatory bodies.

But is the privacy of cryptocurrency assets really insignificant? Not necessarily.

Generally speaking, blockchains have immutable and transparent characteristics, allowing any crypto asset to be traced on-chain, clarifying the origins and paths of asset transfers. However, in the eyes of some crypto enthusiasts, protecting privacy is necessary. For example, wallets holding large amounts of crypto assets are completely visible on-chain, and with a little analysis, outsiders can relatively easily trace the real entities corresponding to those addresses, such as exchanges, individuals, and institutions.

Once real identities are tracked, these crypto asset whales may become targets for hackers, social engineering scams, or even kidnappings. Therefore, many crypto asset individuals have a strong demand for crypto privacy protection for security reasons.

Throughout the development of blockchain, various privacy protection solutions have emerged. In addition to mixers like Tornado, privacy-focused blockchain networks such as Monero and Zcash have also been developed.

Monero anonymizes the identities of senders and receivers by disguising the addresses used by participants, while Zcash uses zero-knowledge proofs to verify transactions without revealing details about the sender, receiver, or transaction amount.

These privacy-protecting blockchains can anonymize transactions and make them difficult to trace, essentially meeting the demand for privacy protection. However, it must be emphasized that wherever there is privacy in the cryptocurrency asset industry, there is also a tendency for crime to flourish.

Previously, Monero became a hotbed for ransomware groups and dark web market users to carry out illegal activities, leading the U.S. IRS to offer a reward of $625,000 for technology capable of tracking Monero; Zcash is also frequently used in dark web transactions, second only to Monero.

Monero is frequently used for hacker money laundering and dark web transactions

Between privacy and illicit activities, mixers and privacy chains exhibit a double-edged sword characteristic.

It is worth noting that due to the increasing frequency with which mixers represented by Tornado are used as money laundering tools, the recent U.S. regulatory sanctions against them have not sparked much opposition in the cryptocurrency industry. This somewhat indicates that industry participants are also deeply opposed to the criminal activities of hackers attacking blockchains and using crypto assets for scams and money laundering.

According to a report released by the analysis company Chainalysis in mid-July, the usage of mixers reached a historic high in 2022, with growth primarily coming from centralized exchanges, DeFi protocols, and addresses associated with illegal activities. Of the crypto assets obtained through mixers, 23% were acquired illegally, a higher proportion than the 12% in 2021, with "almost 10% of funds from illegal addresses specifically sent to cryptocurrency mixers."

When hackers and criminal organizations use crypto assets for illegal activities, it somewhat stigmatizes blockchain and cryptocurrency assets, which is detrimental to the positive development of the industry. Therefore, industry insiders believe that regulatory bodies should strike a balance between privacy protection and crime reduction, which is precisely the area where cryptocurrency technology can realize its true potential.