Shalini Nagarajan

<div id="highlights-block_6357c7fccd73f" class="highlights">
 <ul>
 <li>Guochun He and Zheng Wang sought bitcoin wallet Wasabi to hide bribe payments, Elliptic said</li>
 <li>The pair allegedly hoped to gather confidential documents related to a federal investigation into Huawei</li>
 </ul>
 
</div>



Two Chinese officials tried to hide bitcoin bribes paid to a US double agent with crypto mixing technology, once again thrusting privacy-preserving protocols into public discourse.



In 2019, authorities say Guochun He and Zheng Wang directed a US government employee to steal information about an ongoing criminal investigation into a global telecom company based in the People’s Republic of China (PRC), <a href="https://www.justice.gov/usao-edny/pr/two-chinese-intelligence-officers-charged-obstruction-justice-scheme-bribe-us" target="_blank" rel="noreferrer noopener">according</a> to the Department of Justice (DOJ).&nbsp;



The DOJ doesn’t name the company, but the <a href="https://www.wsj.com/articles/u-s-says-chinese-tried-to-obstruct-huawei-prosecution-11666633408">Wall Street Journal</a> and <a href="https://www.cnbc.com/2022/10/24/chinese-intelligence-officers-charged-in-huawei-prosecution-obstruction.html">CNBC</a> both reported the firm as Huawei.&nbsp;



The officials, said to be conducting foreign intelligence operations in the interest of Huawei, believed the US government employee was recruited to work for Beijing. He was in fact working with the US Federal Bureau of Investigation (FBI), the complaint alleges.



In Sept. 2021, the Chinese officials assigned the double agent with detailing their meetings with prosecutors at the US Attorney’s office in Brooklyn. 



They were especially interested in understanding which Huawei employees had been interviewed by the government, seeking a description of the prosecutors’ evidence, witness list and trial strategy.



Guochun He, one of the Chinese officials who paid the bitcoin bribes, allegedly told the agent that the company in question was “obviously interested” in the information. He first handed over $41,000 in bitcoin in Oct. 2021 for stealing a document and another lot worth $20,000 in September.



Huawei didn’t return Blockworks’ request for comment by press time.



<h3 class="wp-block-heading">Analytics unit traced bitcoin bribes despite Wasabi Wallet</h3>



In private messages, He allegedly asked the agent to accept bitcoin as he believed it would be &#8220;private and safe&#8221; from the eyes of the government.



Crypto has long been considered a means of engaging in discrete transactions, but mostly the opposite is true. Blockchain data, at its core, is almost always public and transactions are traceable, albeit pseudonymous.&nbsp;



Crypto mixers were designed to provide privacy for this open financial system. There are many different kinds but they generally work by commingling funds with other users. 



Mixers have increasingly come under the spotlight after usage by North Korean hackers and other bad actors in laundering illicit crypto gathered from exploits across the crypto ecosystem alongside ransomware attacks.



<figure class="wp-block-image size-large"><img decoding="async" loading="lazy" width="1024" height="243" src="https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png" alt="" class="wp-image-35480" srcset="https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png?w=1024 1024w, https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png?w=300 300w, https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png?w=768 768w, https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png?w=1536 1536w, https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png?w=428 428w, https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png?w=470 470w, https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png?w=389 389w, https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png?w=80 80w, https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png?w=50 50w, https://blockworks-co.imgix.net/wp-content/uploads/2022/10/Screen-Shot-2022-10-25-at-14.01.26-1024x243.png?w=1922 1922w" sizes="(max-width: 1024px) 100vw, 1024px" /><figcaption>Excerpt from DOJ <a href="https://www.justice.gov/usao-edny/press-release/file/1546456/download" target="_blank" rel="noreferrer noopener">indictment</a>.</figcaption></figure>



The US recently banned citizens from using Ethereum-powered crypto mixing service <a href="https://cms.blockworks.co/us-treasury-bans-citizens-from-using-mixing-service-tornado-cash/" target="_blank" rel="noreferrer noopener">Tornado Cash</a> for this reason.&nbsp;



Blockchain analytics firm Elliptic found that the two officials used bitcoin wallet Wasabi Wallet to conceal their transactions. Wasabi <a href="https://wasabiwallet.io/about.html" target="_blank" rel="noreferrer noopener">describes</a> itself as an open-source, non-custodial bitcoin wallet created to provide privacy by default. 



The wallet makes use of tech known as &#8220;<a href="https://en.bitcoin.it/wiki/CoinJoin" target="_blank" rel="noreferrer noopener">CoinJoin</a>,&#8221; which combines bitcoin of multiple transacting parties to render identifying fund provenance more difficult.



“All of the bribe payments can be traced back to Wasabi,” Elliptic <a href="https://hub.elliptic.co/analysis/chinese-spies-used-wasabi-wallet-mixer-to-pay-bitcoin-bribes-to-fbi-double-agent/" target="_blank" rel="noreferrer noopener">said in a statement</a>. Tom Robinson, co-founder and chief scientist at Elliptic, told Blockworks the firm was able to identify the bitcoin transactions based on details disclosed in the criminal complaint.



Elliptic was then able to use its blockchain analytics tools to trace the source of the payments and identify the use of Wasabi. Wasabi Wallet didn’t immediately return Blockworks’ request for comment.



<figure class="wp-block-image"><img decoding="async" src="https://lh3.googleusercontent.com/dDI2mJS2Dapq0klRiFWfX3fDsGarHVV-zKFl41X-5H1RxxUR8hyss_-YvCNRBZf5lneYNs3BnVu1eUb_pS8PSNwOauW2iCGdOb4uiOkdzw-IPV7MM4M2-hoELWThQiK1pFR2J6_kd_CP_cj7k6KLG041yFKPZTQzhi8CeMv3s3EZsfGDE6uFJKbMFw" alt=""/><figcaption>Image source: Elliptic</figcaption></figure>



Both officials are charged with attempting to obstruct a criminal prosecution of Huawei in the federal district court in the Eastern District of New York. He is additionally charged with two counts of money laundering based on bribe payments.&nbsp;



They currently remain at large. If convicted, He faces up to 60 in prison and Wang faces up to 20 years.



In any case, the matter once more highlights the difficulty of hiding crypto activity — whether illicit or benign — even after funds are sent through crypto mixing technology such CoinJoin.&nbsp;



Elliptic’s Robinson told Blockworks the firm has “special techniques for identifying bitcoin addresses associated with Wasabi use.”



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Chinese Officials Hoped CoinJoin Would Hide Bitcoin Bribes

<div id="highlights-block_63060b4c7d15c" class="highlights">
 <ul>
 <li>Sanctioning open-source code impacts the right to privacy, congressman Tom Emmer said</li>
 <li>Emmer also questioned whether recipients of the Tornado Cash &#8216;dust attack&#8217; were in breach of the law</li>
 </ul>
 
</div>



Tornado Cash has sparked debate over privacy and free speech ever since the US Treasury sanctioned the crypto mixer earlier this month — prompting US congressman Tom Emmer to weigh in.



Emmer, a Republican, wrote a <a href="https://twitter.com/RepTomEmmer/status/1562084891247902721" target="_blank" rel="noreferrer noopener">four-page letter</a> to US Treasury secretary Janet Yellen on Tuesday, asking her office to clarify its decision to blacklist Tornado Cash.



On August 8, the Office of Foreign Asset Control (OFAC) <a href="https://cms.blockworks.co/us-treasury-bans-citizens-from-using-mixing-service-tornado-cash/">added</a> 45 Ethereum addresses linked to Tornado Cash to its Specially Designated Nationals (SDN). US citizens would no longer legally be allowed to use the protocol or interact with its addresses.



Dutch police then arrested Tornado Cash developer Alexey Pertsev in Amsterdam over his suspected role in facilitation of money laundering, leading to a <a href="https://cms.blockworks.co/tornado-cash-developers-arrest-sparks-protest-in-amsterdam/" target="_blank" rel="noreferrer noopener">protest rally</a> in the city&#8217;s historic Dam Square last weekend.



The SDN list generally includes groups or people who are controlled or acting on behalf of specific countries, such as Iran and North Korea. In Emmer’s letter, the congressman pointed out the Tornado Cash sanctions were unique as they targeted “privacy-enabling” code, rather than a person or entity.



“The sanctioning of neutral, open-source, decentralized technology presents a series of new questions, which impact not only our national security, but the right to privacy of every American citizen,” Emmer wrote.



When used effectively, <a href="https://cms.blockworks.co/the-purpose-and-perils-of-crypto-privacy-tools/" target="_blank" rel="noreferrer noopener">crypto mixers</a> like Tornado Cash can help people keep their crypto transactions private by mixing funds in a pool of assets belonging to multiple users.&nbsp;



Use cases unrelated to money laundering for crypto mixers exist: Ethereum co-founder Vitalik Buterin, born in Russia, <a href="https://twitter.com/VitalikButerin/status/1556925602233569280" target="_blank" rel="noreferrer noopener">tweeted</a> that he’s used the protocol while donating to pro-Ukrainian causes.&nbsp;



US authorities claim Tornado Cash was used to launder more than $7 billion in cryptocurrencies since its 2019 launch, including over $455 million allegedly stolen by Lazarus Group, the hacker crew believed to be sponsored by Pyongyang.



Although, that figure aligns with the total value of cryptocurrency sent through the mixer overall, per a Dune Analytics <a href="https://dune.com/poma/tornado-cash_1" target="_blank" rel="noreferrer noopener">dashboard</a>. Blockchain analytics unit Elliptic <a href="https://hub.elliptic.co/analysis/tornado-cash-mixer-sanctioned-after-laundering-over-1-5-billion/">reported</a> earlier this month that around $1.5 billion in illicit funds had been moved through Tornado Cash.



The crypto industry does not encourage money laundering or other forms of illicit transactions, Anthony Georgiades, co-founder of Pastel Network, told Blockworks.&nbsp;



“My hope is that lawmakers, law enforcement and regulators can work with the crypto space to stop bad actors while also protecting the right to privacy and speech,” he said.



In any case, Emmer asked Yellen’s office to confirm whether ordinary Americans who received unsolicited funds from sanctioned addresses are in breach of the law.&nbsp;



Anonymous parties had sent 0.01 ETH ($16.38) to a number of prominent figures across the crypto ecosystem via Tornado Cash in defiance of OFAC&#8217;s sanctions, <a href="https://cms.blockworks.co/defi-web-apps-block-users-hit-by-tornado-cash-dust-attack/" target="_blank" rel="noreferrer noopener">leading to blocks</a> from DeFi web apps such as Aave and Uniswap.



Coinbase CEO Brian Armstrong and Tron founder <a href="https://cms.blockworks.co/justin-suns-plot-to-divide-ethereum-off-to-rocky-start/" target="_blank" rel="noreferrer noopener">Justin Sun</a> were among the recipients, as well as addresses linked to celebrities such as Shaquille O’Neal and Jimmy Fallon.&nbsp;



Emmer said he shared OFAC’s concerns about the illicit use of Tornado Cash, but: “technology is neutral, and the expectation of privacy is normal.”



David Canellis contributed reporting.



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Treasury Must Clarify Tornado Cash Sanctions, Congressman Says

<div id="highlights-block_630353d1682f7" class="highlights">
 <ul>
 <li>Tornado Cash developer Alexey Pertsev was arrested earlier this month over alleged facilitation of money laundering</li>
 <li>Privacy advocates worry Pertsev’s arrest could have damaging consequences for open-source coders</li>
 </ul>
 
</div>



Supporters of Tornado Cash developer Alexey Pertsev gathered in Amsterdam to protest over the weekend, almost two weeks after he was <a href="https://cms.blockworks.co/netherlands-arrests-suspected-tornado-cash-dev-days-after-us-sanctions/" target="_blank" rel="noreferrer noopener">arrested</a> in the Dutch capital.



Dutch financial crimes agency FIOD suspects the 29-year-old programmer of facilitating money laundering through the <a href="https://cms.blockworks.co/crypto-mixers-and-privacy-coins-can-they-resist-censorship/" target="_blank" rel="noreferrer noopener">crypto-mixing</a> service. But the agency hasn’t specified under which laws Pertsev was arrested. He is yet to be charged with a specific crime, per the latest available information.



Pertsev’s arrest has sparked widespread backlash among open source developers, and an online <a href="https://www.change.org/p/open-source-development-is-in-danger-take-action-before-it-s-too-late-opensourcenotacrime-privacynotacrime-freealex-freepertsev-freealekseypertsev?recruiter=false&amp;utm_source=share_petition&amp;utm_medium=twitter&amp;utm_campaign=psf_combo_share_initial&amp;utm_term=petition_dashboard&amp;recruited_by_id=9309d090-1e59-11ed-8a28-6f6d0c34746d&amp;share_bandit_exp=initial-34212517-en-US" target="_blank" rel="noreferrer noopener">petition</a> decrying his detention has garnered almost 2,000 signatures.



DeFi (decentralized finance) aggregator 1inch Network had <a href="https://twitter.com/1inch/status/1560326568148226048" target="_blank" rel="noreferrer noopener">called on individuals</a> to join a protest rally in Amsterdam’s historic Dam Square, arguing developers, including Tornado Cash programmers, hold no control over how their code is used.



On Saturday, over 50 protesters held placards with slogans including: “Free Alex Pertsev,” “Writing open source code is not a crime,” and, “Will you arrest a gun maker for facilitating public shooting?”



<figure class="wp-block-embed is-type-rich is-provider-twitter wp-block-embed-twitter"><div class="wp-block-embed__wrapper">
<blockquote class="twitter-tweet" data-width="550" data-dnt="true"><a href="https://twitter.com/hashtag/opensource?src=hash&amp;ref_src=twsrc%5Etfw">#opensource</a> is not a crime.<a href="https://twitter.com/hashtag/privacy?src=hash&amp;ref_src=twsrc%5Etfw">#privacy</a> is a human right. Thank you to our brothers and sisters in Amsterdam for going out to protest these self-evident truths. <a href="https://t.co/SFIAfT6I5n">https://t.co/SFIAfT6I5n</a>&mdash; Lefteris Karapetsas | Hiring for @rotkiapp (@LefterisJP) <a href="https://twitter.com/LefterisJP/status/1561038476832915458?ref_src=twsrc%5Etfw">August 20, 2022</a></blockquote><script async src="https://platform.twitter.com/widgets.js" charset="utf-8"></script>
</div></figure>



The Change.org petition, created by Helsinki-based product manager Daria Mironova, states the “accusations against Alex threaten to kill the entire open-source software segment.”



US authorities believe Tornado Cash is a primary tool for North Korean hacker crew Lazarus Group in laundering stolen cryptocurrency.&nbsp;



Earlier this month, the US Treasury sanctioned the mixer’s blockchain addresses, among others, rendering it illegal for US persons to interact with the tool.



The mixer’s front-end web app is now offline, although the actual protocol — which is powered by smart contracts — persists on the Ethereum blockchain.



Pertsev’s wife Ksenia Malik <a href="https://cointelegraph.com/news/wife-of-arrested-tornado-cash-dev-forbidden-to-speak-with-him-rally-organized" target="_blank" rel="noreferrer noopener">told Cointelegraph</a> last week that she hasn’t got the chance to contact him after authorities took him in. 



Malik said she didn&#8217;t expect someone could be arrested for writing open source code and expressed gratitude for support shown.



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Tornado Cash Developer’s Arrest Sparks Protest in Amsterdam

John Gilbert

<div id="highlights-block_62ffd7f9362bf" class="highlights">
 <ul>
 <li>People across Twitter are protesting sanctions by making resistance art out of the banned Tornado Cash addresses</li>
 <li>This renewed interest has inspired creative solutions that use privacy coins to provide a base-layer of anonymity in Web3</li>
 </ul>
 
</div>



In response to the sanctions, advocacy groups such as <a href="https://www.coincenter.org/analysis-what-is-and-what-is-not-a-sanctionable-entity-in-the-tornado-cash-case/" target="_blank" rel="noreferrer noopener">Coin Center</a> have come to the mixer&#8217;s defense — arguing that the smart contract code is not a sanctionable entity.&nbsp;



With this new precedent, it is unclear if privacy coins such as <a href="https://www.getmonero.org/" target="_blank" rel="noreferrer noopener">Monero</a> will face similar censorship. A hard fork update on Aug. 13 reportedly made Monero transactions <a href="https://www.getmonero.org/2022/04/20/network-upgrade-july-2022.html" target="_blank" rel="noreferrer noopener">harder to trace</a> — potentially closing any back doors law agencies used to track transactions.&nbsp;



The view that any cryptocurrency transaction is private by default is a common misconception. In fact, the opposite is true. Blockchain data is public and transactions are traceable. Crypto mixers and privacy coins were created to provide privacy for this open financial system. But both face different uphill battles. Before analyzing the likelihood of either’s success, we need to explain how they work, where they differ and the regulatory strategy game of financial censorship.&nbsp;



<h3 class="wp-block-heading">So what is a crypto mixer?</h3>



A crypto mixer, also known as a tumbler or blender, is a transaction mixing tool or service that anyone can use to obscure a crypto wallet’s source of funds. These tools were first created for<a href="https://academy.bit2me.com/en/que-es-coinjoin/#:~:text=CoinJoin%20Origin,modification%20in%20the%20Bitcoin%20protocol." target="_blank" rel="noreferrer noopener"> bitcoin in 2013</a> but became a popular alternative to privacy coins once solutions like Tornado Cash made it available for a variety of cryptoassets.



There are two types of crypto mixers: custodial and non-custodial. Custodial blenders such as blender.io are central entities that take full custody of funds to mix transactions. Users pay a fee for the service and trust the entity to return their funds once the transactions are blended.



Blender.io was the first mixer to be sanctioned by US Department of the Treasury’s Office of Foreign Assets Control (OFAC). It did not receive the same attention as Tornado Cash because it fell under the pattern of previous sanctions made against persons and entities. A North Korean state-sponsored hacker collective known as the Lazarus Group reportedly used the service after a <a href="https://cms.blockworks.co/the-ronin-hacker-made-off-with-625m-of-crypto-but-cashing-out-isnt-so-easy/" target="_blank" rel="noreferrer noopener">hack against Axie Infinity</a> that resulted in a $620 million loss.



<h4 class="wp-block-heading" id="tornadocash">How non-custodial crypto mixers like Tornado Cash works</h4>



Tornado Cash is an Ethereum based crypto blender that uses non-custodial smart contracts to mix ETH and ERC-20 tokens. Users send funds to smart contract addresses that organize them by amount and effectively mix the deposits through a zero-knowledge proof contract. 



For example, say you want to mix 11 ETH. Since deposits are organized by amount, you could deposit 10 ETH to the 10 ETH mixer and 1 ETH to the 1 ETH mixer. Once funds are sent to each blender, the zero-knowledge proof would verify you sent a deposit to each one without revealing which one was originally yours. This essentially gives you the equivalent of a withdrawal permission slip for each mixer.&nbsp;



So if you were to use the permission slips to withdraw both deposits, it would be close to impossible for any outside observer to identify the correct source of funds. They would see a myriad of potential options.



The tool provides pretty good financial privacy by breaking the link between the sender and receiver. But it’s not perfect; theoretically, third party blockchain intelligence could use outside data and behavior models in an attempt to deduce which transaction history belongs to the tokens on your new wallet address.&nbsp;



<h4 class="wp-block-heading">Legal challenges</h4>



On Aug. 8, 2022, <a href="https://home.treasury.gov/news/press-releases/jy0916" target="_blank" rel="noreferrer noopener">OFAC added a list of addresses</a> associated with Tornado Cash to the same list of sanctioned addresses where Blender.io ended up. This was in response to news that the Lazarus Group used the tool to launder $455 million in stolen funds.



OFAC used the same messaging and reasoning as it did Blender.io, but it did not acknowledge the key custodial difference between the two. In <a href="https://www.coincenter.org/analysis-what-is-and-what-is-not-a-sanctionable-entity-in-the-tornado-cash-case/#fn2" target="_blank" rel="noreferrer noopener">Coin Center’s full analysis</a>, they argue that Tornado Cash has two separate elements: The decentralized group of governing members they call “Tornado Cash Entity” and the immutable smart contract coin mixers they call “Tornado Cash Application.”&nbsp;



The Tornado Cash Entity cannot update or change the Tornado Cash Application because the original creators destroyed their admin keys. The smart contracts will exist as long as the Ethereum blockchain continues to operate. So even though the Tornado Cash website is down, anyone can spin up a new front end — or interface with the smart contracts directly — that lets users access the same mixers.



The problem is that OFAC included these immutable smart contract addresses in the list of sanctions. So there are now innocent Americans with funds still in these mixers. If they attempt to move the funds, they will be breaking the law and subject to penalty. And because the application is not an entity, it has no means to petition OFAC for sanction removal.



Coin Center further argues that because the Tornado Cash Application is not an entity, OFAC did not cite the proper authority to add the smart contract addresses to the sanctions list. This marks an unprecedented move with potential constitutional issues.&nbsp;



In response to OFAC’s announcement, companies agreed to censor anyone connected to these addresses. The decentralized finance app Aave blocked any users that had Tornado Cash funds sent to them in a <a href="https://cms.blockworks.co/defi-web-apps-block-users-hit-by-tornado-cash-dust-attack/" target="_blank" rel="noreferrer noopener">dust attack</a>. The team behind <a href="https://cms.blockworks.co/wallets-banned-by-uniswap-labs-for-alleged-crimes/">Uniswap later followed suite by banning 253 wallet addresses</a> connected to the mixer. Circle also censored users by <a href="https://cms.blockworks.co/treasurys-tornado-cash-sanctions-have-companies-stepping-back-from-users/" target="_blank" rel="noreferrer noopener">freezing 75,000 usd coin stablecoins</a> in the smart contracts. The Blockworks’ Empire podcast explains how that is possible in a <a href="https://twitter.com/theempirepod/status/1559941409590849538?s=20&amp;t=TJiyYN8fAO7m-9S77iQSBg" target="_blank" rel="noreferrer noopener">Twitter thread</a>.



<h3 class="wp-block-heading">What are privacy coins and how do they differ?</h3>



Privacy coins are cryptocurrencies that use a variety of approaches to obscure IP addresses, wallet balances and the flow of funds from public view. They differ from crypto mixers in that they make financial privacy less of a feature and more of a product. As a result, they only provide privacy to transactions made in a specific currency.&nbsp;



The two most popular privacy coins are Z-cash and Monero. Z-cash is a cryptocurrency that relies primarily on zero-knowledge proofs to shield transaction info. In October 2018, <a href="https://electriccoin.co/blog/zcash-counterfeiting-vulnerability-successfully-remediated/" target="_blank" rel="noreferrer noopener">Z-cash announced</a> that they fixed an 8-month-old bug in proofs that could have permitted an infinite inflation of supply. Due to transaction privacy, it was unclear how much was actually inflated.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;



Since this early stumble, z-cash has never returned to the highs of the 2017 bull cycle and currently ranks second to Monero in total privacy coin market cap. While monero was able to once again reach similar prices of the 2017 market, it failed to break its all-time high in 2021.&nbsp;&nbsp;



Monero is a privacy coin that offers financial anonymity through layers of privacy-enhanced blockchain encryption. Every transaction utilizes single-use stealth addresses to prevent the visibility of public address balances. So only users with a wallet&#8217;s private key can map its balance back to a public address. It also uses ring signatures to obscure the source of funds in a transaction by including random addresses in the verification signature.&nbsp;



<h4 class="wp-block-heading">Privacy challenges</h4>



The Monero protocol was upgraded on Aug. 13. While the previous version of Monero offered a layer of privacy, its complete untraceability was debatable. In 2018, critics claimed that inputs in a signature ring could be deduced through a <a href="https://scholar.princeton.edu/kevinlee/publications/empirical-analysis-traceability-monero-blockchain" target="_blank" rel="noreferrer noopener">process of elimination</a>. And in 2021, <a href="https://ciphertrace.com/enhanced-monero-tracing/#:~:text=CipherTrace%20takes%20Monero%20tracing%20capabilities,to%20better%20trace%20suspicious%20activities" target="_blank" rel="noreferrer noopener">CipherTracer reportedly</a> patented a method that the Department of Homeland Security (DHS) uses to trace transactions.&nbsp;



Even if CipherTracer discovered real vulnerabilities, the extent of their impact is unclear. They didn’t disclose their methods or success rate. This previous version still provided a degree of financial privacy in the sense that it blocked anyone not willing to pay CipherTracer.&nbsp;



But this disincentive is less resistant to state sanctions and censorship. Theoretically, the state is more willing to spend resources in an attempt to trace addresses — especially if they suspect a connection to crime, or in some countries, political opposition.



In Canada, an effort was made to trace financial contributions to the trucker freedom convoy. The government ended up <a href="https://www.coindesk.com/policy/2022/02/16/canada-sanctions-34-crypto-wallets-tied-to-trucker-freedom-convoy/" target="_blank" rel="noreferrer noopener">sanctioning 34 crypto wallets</a> in connection to the movement, and Monero addresses were included in that list.&nbsp;



The Monero developers hope this update will close any potential vulnerability by increasing the number of transactions in a ring signature. But in response to the update, <a href="https://ciphertrace.com/heads-up-monero-v15-hard-fork-update/" target="_blank" rel="noreferrer noopener">CipherTracer stated</a>, “While Monero’s upcoming chain improvements are significant, the fundamentals of our approach to tracing probable source of funds will still apply after the fork.”



If the upgrade does succeed in closing these back doors, there is concern that OFAC may take similar actions against Monero. In an <a href="https://www.coindesk.com/tech/2022/08/12/privacy-protocol-monero-is-getting-a-major-upgrade/" target="_blank" rel="noreferrer noopener">interview with CoinDesk</a>, a Monero contributor said that, “at the moment, I&#8217;m not concerned about immediate legal action.”



“There is no direct financial incentive…for developers, unlike [the situation with] the Tornado Cash developer,” he said.



These comments seem to infer that the potential ability for the developer to profit from the use of these smart contracts makes him liable. Dutch financial crimes agency <a href="https://cms.blockworks.co/netherlands-arrests-suspected-tornado-cash-dev-days-after-us-sanctions/" target="_blank" rel="noreferrer noopener">FIOD arrested a Tornado Cash developer</a> on suspicion of laundering money through the tool. But it is unclear if that arrest was for his specific attempts to launder money or for his connection to others using it for that purpose.&nbsp;&nbsp;



<h4 class="wp-block-heading">Adoption challenges</h4>



Even though top privacy coins such as monero and z-cash are actively working to increase the privacy of transactions, they have not seen the same degree of adoption as leading layer-1 blockchains such as Ethereum. Many competitors, including <a href="https://scrt.network/about/about-secret-network/" target="_blank" rel="noreferrer noopener">Secret Network</a> and <a href="https://oasisprotocol.org/" target="_blank" rel="noreferrer noopener">Oasis Network</a>, argue that the reason for this lag is that privacy coins do not offer a base layer of privacy that can be used to build Web3.&nbsp;



In 2020 Secret Network was the first privacy based blockchain to enable smart contract programmability. It lives in the Cosmos ecosystem and is working toward a <a href="https://scrt.network/blog/beyond-zk-guide-to-web3-privacy-part-1" target="_blank" rel="noreferrer noopener">vision of Web3 privacy</a>. It has launched multiple apps such as the decentralized messaging service <a href="https://altermail.live/" target="_blank" rel="noreferrer noopener">Altermail</a>, and decentralized exchange <a href="https://sienna.network/swap/" target="_blank" rel="noreferrer noopener">SiennaSwap</a>.&nbsp;



But Secret Network and its competitors face the classic challenge of an overcrowded sector. They still have a long way in overcoming the market dominance of Monero and Z-Cash. The threat of sanctions have motivated <a href="https://twitter.com/zooko/status/1560289669023117313?s=21&amp;t=-dtykJ4X0Nk6E8apIEzBqw" target="_blank" rel="noreferrer noopener">many in the Z-Cash community</a> to explore creating their own smart contract programmability.&nbsp;&nbsp;



<h3 class="wp-block-heading">The future of digital financial privacy</h3>



The battle against financial privacy feels like a game of whack-a-mole. So far, the state has tried two different tools. With crypto mixers, they used the regulatory sanctions hammer. And for privacy coins, they tried blockchain intelligence sleuths.&nbsp;



Their approach may be, if one financial privacy method is too popular with criminals or too hard to trace, they will just shut it down with the hammer.



Advocacy groups such as Coin Center may respond by challenging such actions in court, but that process will take years. The sanctions are very likely hurting innocent Americans in the meantime.



For other privacy solutions, they may use investigations to continue in their cat and mouse chase with developer upgrades.&nbsp;



User adoption, though, is a key element to this game. As more people are drawn to either mixers or privacy coins, the chance of tracing transactions becomes exponentially difficult. Switching analogies, it&#8217;s like the classic police chase down a narrow alley. If the suspect reaches a bustling parade, they can dust off and subtly slip away into the crowd.



If a privacy coin, mixer or base-layer privacy solution gains mainstream adoption, it could have greater resistance to censorship. State officials would struggle to find the political backing for sweeping sanctions or technology needed to crack privacy measures. And the potential Tornado Cash sanctions fallout for Ethereum validators may pull millions more into this conversation.



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Crypto Mixers and Privacy Coins: Can They Resist Censorship?

Casey Wagner

<div id="highlights-block_627586bdeb65b" class="highlights">
 <ul>
 <li>North Korean mixer Blender.io was used to conceal funds from the Ronin Network hack</li>
 <li>The Treasury has already sanctioned the group the FBI said is responsible for the largest cryptocurrency hack to date</li>
 </ul>
 
</div>



The US Treasury Department has levied its first sanctions against a crypto mixing service, or a means of obscuring the origin of a digital asset. 



The Treasury on Friday alleged North Korea-based hacker Lazarus Group — which in March allegedly <a href="https://cms.blockworks.co/fbi-says-north-korea-behind-625m-ronin-hack/" target="_blank" rel="noreferrer noopener">stole $625 million</a> from Ethereum-linked sidechain Ronin Network — used the sanctioned company, Blender.io, to conceal the illicit funds.



Blender was used to launder more than $20.5 million of the hacked cryptocurrency, the Treasury said in a <a href="https://home.treasury.gov/news/press-releases/jy0768" target="_blank" rel="noreferrer noopener">statement</a>. The attack remains the largest crypto hack on record. 



“Virtual currency mixers that assist illicit transactions pose a threat to U.S. national security interests,” said Brian Nelson, under secretary of the Treasury for terrorism and financial intelligence. “We are taking action against illicit financial activity by the DPRK and will not allow state-sponsored thievery and its money-laundering enablers to go unanswered.”



In April, the Treasury in its first move <a href="https://cms.blockworks.co/treasury-sanctions-north-korean-hacker-group-confirms-ties-to-625m-hack/" target="_blank" rel="noreferrer noopener">sanctioned Ethereum addresses</a> linked to Lazarus Group.



The news comes as the digital asset industry continues to evaluate the role and risks of <a href="https://cms.blockworks.co/the-purpose-and-perils-of-crypto-privacy-tools/" target="_blank" rel="noreferrer noopener">mixer services</a>. Hackers used mixing service Tornado Cash to try to conceal 5,400 stolen ether linked to April’s $80 million <a href="https://cms.blockworks.co/hacked-crypto-platform-offers-no-questions-asked-10m-bounty-for-stolen-funds/" target="_blank" rel="noreferrer noopener">Fei Protocol hack</a>, according to BlockSec Chief Technology Officer Lei Wu.



The services, while known to be often linked to money laundering, are not illegal.



“There are legitimate privacy concerns that [mixers] can help address,” Kim Grauer, director of research at Chainalysis, said during a panel at the <a href="https://cornellblockchain.org/" target="_blank" rel="noreferrer noopener">Cornell Blockchain Conference</a> in New York. “There is a lot of hacking happening, which is another bad impact of growing so fast, but there&#8217;s also an opportunity there to build more secure platforms.”



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