Welcome to Swarm Markets’ media memo. This weekly update provides comments from Swarm Markets’ co-founders, Philipp Pieper and Timo Lehes, on key industry news that has caught our eye, plus our own developments.
This week’s memo will purely focus on the Tornado Cash sanctions, highlighting key DeFi challenges
The news that Tornado Cash was sanctioned by the U.S. Department of the Treasury’s OFAC list has profoundly rocked the crypto and DeFi community. It’s the first piece of code—not a person— to be sanctioned, demonstrating the long reach of regulators, even into decentralized infrastructure.
At Swarm, we agree with other crypto CEOs that sanctioning Tornado Cash is unconstitutional and an overreach from regulators. There are a few things to unpack here.
Mixing services can form a legitimate part of security architecture. In TradFi, we use privacy tools to hide the balance in our current accounts. Similarly, legal privacy mechanisms are necessary for the development of DeFi.
Privacy is a fundamental right in almost every country, enshrined in a constitution or other legal provision. The code itself is not unlawful even though it can be used unlawfully. Tornado Cash differs because it is decentralized, making it difficult to control who can use it.
2. Freedom of speech
Dutch authorities tracked down one of the developers, Alexey Pertsev, showing regulatory authorities and enforcement institutions are beginning to coalesce and raising even thornier questions.
That Pertsev, who has not been charged with a crime, may potentially be held criminally liable for writing code is striking. Under freedom of speech—aka code—Pertsev’s arrest would not hold up in a European court of law. See Bernstein v U.S. 1996 case for establishing code as speech.
3. Adequacy of DeFi infrastructure
Permissionless decentralized protocols do not have the adequate architecture to react to the Tornado Cash sanctions. As a result, such protocols are being forced to inadvertently penalize and block law abiding users from their services.
Third party APIs are too simplistic, returning true/false results on wallets that have interacted with Tornado Cash. Users who are victims of hacks, whose coins were sent to Tornado Cash to hide the ill-gotten funds, are being grouped with bad actors & blocked by DeFi platforms.
Adding identification layers to permissionless infrastructure benefits positive screening and keeps harmful players out. It can provide clarity to relevant authorities and the market on who is participating. However, that does not mean there should be a blanket ban on permissionless structures, or privacy tools, they just need to be built along regulatory lines.
4. A compliant approach
DeFi infrastructure must be built along regulatory lines. Swarm is skating to where the puck is headed by being fully compliant from day one, applying KYC and AML checks to all counterparties and wallets wanting to interact with Swarm contracts.
With lawmakers now working together, regulation is now an undeniable reality for the DeFi space. Working with regulators will help bring confidence to the sector at this critical time.