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Below is a portion taken from the full article found . The full article covers:
Tornado Cash Sanctions
Post-Sanctions Ripple Effects
Sanctions Complicate The Merge
What Are Ethereum's Options?
is an open-source, public blockchain network aiming to create "a platform for deploying and executing smart contracts," enabling a decentralized world computer known as the Ethereum Virtual Machine (EVM). The EVM serves as a distributed, permissionless global computing environment that the entire world can access. It runs based on specific rules encoded into the protocol and updates the global state (transactions, wallets, smart contracts, etc.) with each block according to the specifications. In doing so, the entire globally-diverse Ethereum ecosystem, comprised of hundreds of thousands of users and projects, can reach network consensus without a central third party.
The Ethereum network serves as an opt-in alternative to the traditional banking and financial solutions offered/forced upon people by banks and their governments. Similar to the internet, it has no borders or political alliances. It simply exists: neutral, apolitical, and blissfully unaware of anything outside its EVM specs.
The primary use of the platform and the reason for its proliferation is the ability to code and run smart contracts on the network. Building dApps based on smart contracts has many major advantages. Among them, dApps are permissionless, transparent, uncensorable, and have removed the need for intermediaries. No intermediaries = no seeking rent, collusion, extortion, or censorship.
Cryptocurrency pioneer Nick Szabo proposed the initial idea for smart contracts. Essentially, smart contracts are programs that run autonomously on the network, exactly as programmed, without any possibility of downtime, censorship, fraud, or third-party interference. A smart contract is written as programming code and deployed to the blockchain instead of having lawyers enforce the contract's rules. The contract runs automatically following the logic laid out in the code.
The primary benefit of smart contracts is that they enable Ethereum—and other blockchains—to do more than simply send tokens between users whenever initiated.
When programmers create smart contracts, they determine the operations the contract will support—and any restrictions—then "deploy" it onto the network. Once a smart contract's code is added to Ethereum's database, it acquires its unique address and then lives on in perpetuity. Any user can interact with the program to execute the rules and operations it supports automatically.
Smart contracts are immutable, meaning that no developer/user/government can delete or modify them once deployed. *Note: Smart contract authors can encode the ability to upgrade the smart contract; however, this must be incorporated into the code from the very beginning, before its deployment onto the network.*
Tornado Cash Sanctions
Tornado Cash (TC) is an open-source crypto project that aims to provide Ethereum users voluntary privacy as opposed to the default public and transparent nature of transactions on the network. As with many similar projects, TC is not a legal organization but rather a collection of open-source code libraries created by numerous global contributors over the course of years. When referencing TC, people are referencing the collection of liquidity pools that exist on Ethereum as smart contracts. Like many smart contracts on Ethereum, most TC smart contracts are immutable.
TC pools offer users privacy by enabling a user to deposit funds in a pool and then withdraw them to another. Notably, although these deposit and withdrawal events are recorded publicly on Ethereum, TC obfuscates any on-chain link between the original deposit address and the withdrawal address. TC relies on a large number of users using their pools to provide adequate privacy/deniability. It is easier to hide in a crowd of 10,000 than just 10.
With enough "coverage from the crowd" and some help from zero-knowledge cryptography, users can now confidently use the new withdrawal funds how they see fit without linking back to their entire Ethereum transactional history.
Critical to Tornado Cash (and the ethos of cryptocurrencies) is that users can only withdraw the tokens they initially deposited. This means Tornado Cash pools are non-custodial. In other words, a user who deposits and subsequently withdraws tokens retains complete ownership and control over their tokens even as they move through the pool. A third party never compels a user to cede ownership of their tokens.
However, in a truly first-of-its-kind and unprecedented move, on August 8, 2022, the U.S. Treasury's Office of Foreign Assets Control (O.F.A.C.) sanctioned Tornado Cash (TC), based on claims it was used by infamous North Korean hackers, the Lazarus Group, to launder stolen funds. This ruling marks the first time code has been sanctioned on the Specially Designated Nationals And Blocked Persons List (S.D.N.).
Due to its privacy-preserving characteristics, TC has become a popular choice for privacy advocates, including cybercriminals. Although there is near irrefutable evidence that hackers such as the Lazarus Group were users of TC, on-chain forensic companies like Chainalysis suggest just ~10.5% of the assets transmitted through the Tornado Cash protocol were stolen funds.
In their atypical ruling akin to sanctioning airplanes because of hijackings, the Treasury has caused ripple effects across Ethereum, not just for TC or privacy tools. The second-order effects and fallout from such a ruling impact nearly everything built on Ethereum, from DeFi dapps to stablecoins to future validation methods once the network switches to proof of stake (PoS).
Post-Sanctions Ripple Effects
Immediately following the announcement of the sanctions, dapps built atop Ethereum and other ancillary companies based in the U.S. took action to ensure they were compliant with the new ruling. Non-compliance with O.F.A.C. rules is a serious offense punishable by considerable jail time. Because of this,
- U.S.D.C. froze related tokens
- Aave, Uniswap, and other DeFi front-end applications censored the blacklisted addresses
- Infura and Alchemy censored affected addresses from their services
- Ethereum's largest mining pool, Ethermine, began omitting blacklisted addresses
- GitHub took down Tornado's codebase and accounts
- A Tornado developer was arrested
Additionally, many stablecoins and DeFi protocols rely on U.S.D.C., a stablecoin issued by a U.S.-compliant centralized company, Circle. Circle has been steadfastly unambiguous that they pride themselves on U.S.-compliance and abiding by all regulations. Should U.S.D.C. be asked to comply, it is near certain they would. In this case, tens of billions of Ethereum TVL become non-fungible. The cascading effects would be immense, and a chain split into an OFAC-compliant chain and a "neutral" chain become more likely.
Beyond U.S.D.C., Ethermine's mining is responsible for ~25% of Ethereum's hashrate, a considerable portion to be subjected to censorship. Fortunately, mining pools provide a service, and any miner who disagrees with Ethermine's censorship can remove their hashrate and join another pool. Additionally, thanks to Ethereum's decentralization, one mining pool does not threaten the health or integrity of the network.
However, things get a bit more complicated once Ethereum moves to PoS on ~September 15, 2022…
Sanctions Complicate The Merge
After The Merge, Ethereum will no longer utilize proof of work (PoW) secured by miners and hash power. Rather, miners are replaced with validators who stake capital (in the form of ETH) to secure the network. While the majority of hash power in PoW was dominated by just a few mining pools, the ability for a miner to easily move to another pool (as previously discussed) whenever they so choose was a powerful tool in the check-and-balance system. Should a mining pool do anything a user does not agree with (attack the network, conform to sanctions, charge too high fees, etc.), the user can move to a competitor.
Unfortunately, as Ethereum exists today, the same dynamic does not exist in PoS. Currently, users must stake their ETH and "lock it up" until the core protocol releases the Shanghai upgrade that enables staking withdrawals. This was always the plan in the Ethereum roadmap and was spaced out for security reasons, but the fact remains withdrawals are not expected until 6-12 months post-Merge (~2023). Until then, ETH is locked in place.
Again, unfortunately for Ethereum, a substantial portion of the 11M+ ETH that is currently staked resides in U.S.-based companies. Exchanges like COINBASE and Kraken, as well as liquid staking pools like Lido, hold ~50% of the staked ETH.
Lido's stake is not easily recognizable because it is split among various validators. However, as a whole, Lido's staking market share is ~31%.
This means the vast majority of validators on Ethereum are operated by a few U.S.-compliant companies. Ethereum will/has become vulnerable to U.S. regulations that are at odds with the core principles of the protocol. What happens if O.F.A.C. demands that these corporations censor specific transactions? Will they comply and invoke censorship into the protocol?
One data point on this still hypothetical scenario came from Coinbase's C.E.O. Brian Armstrong on Twitter. Armstrong stated that the company would (potentially) opt to shut down its staking service rather than censor transactions at the protocol level in order to comply with the O.F.A.C. sanctions. This would be no trivial decision for Coinbase or Ethereum, as once The Merge goes live, Coinbase is expected to be the third largest validator on Ethereum.
What Are Ethereum's Options?
To continue reading about how Ethereum plans to mitigate this and the rest of the full article, click
