Tag Government

From Monday’s opinion by Judge T. Kent Wetherell, II (N.D. Fla.) in Coin Center v. Yellen (for a similar decision, see this August post about Van Loon v. Dep’t of Treasury):

Plaintiffs argue that [the government’s restriction on the use of] Tornado Cash [a mechanism for further anonymizing cryptocurrency transactions] violated the First Amendment because it chilled Plaintiffs’ protected rights of association by blocking a financial privacy tool they relied on to make donations to organizations and causes and it was not narrowly tailored to achieve its aims. Defendants responds that the First Amendment was not implicated by OFAC’s designation of Tornado Cash and, and even if it was, the designation satisfies the requisite level of scrutiny.

Plaintiffs do not cite any authority supporting the existence of a First Amendment right to use a particular service or type of currency to make donations for charitable or other purposes. The freedom of association cases cited by Plaintiffs are distinguishable because those cases involve government action that compelled private associations to disclose their major donors or members. See Americans for Prosperity Found. v. Bonta (2021); Gibson v. Florida Legislative Investigation Comm. (1963). Here, the designation of Tornado Cash did not compel private associations to disclose anything about their donors or members.

The Court did not overlook Plaintiffs’ reliance on Meyer v. Grant (1988), for the proposition that the government violates the First Amendment when it “restricts access to the most effective, fundamental, and perhaps economical avenue of political discourse.” However, that case does not help Plaintiffs here for two reasons.

First, Meyer is a free speech case that dealt with the chilling consequences that a ban on paying the circulators of initiative petitions would have on disseminating “political discourse.” Here, Plaintiffs have raised a freedom of association claim, not a free speech claim.

Second, the designation of Tornado Cash does not preclude Plaintiffs (or anyone else) from spending money or donating money for political ends, nor does it preclude organizations from accepting anonymous donations. The fact that Tornado Cash may be Plaintiffs’ preferred way of maintaining their financial privacy does not mean that it is the only way for them to do so. Indeed, it is noteworthy that one of the plaintiffs stated in his declaration that Tornado Cash is used “in his regular rotation of privacy tools,” which implies that there are other privacy tools that are available to Plaintiffs.

Accordingly, for the reasons stated above, the Court finds that the designation of Tornado Cash did not implicate Plaintiffs’ First Amendment rights. {Based on this conclusion, the Court need not consider what level of scrutiny applies to the designation of Tornado Cash or whether the designation would withstand that level of scrutiny.}

Here’s more on the legal backstory:

The International Emergency Economic Powers Act (IEEPA) authorizes the President to declare national emergencies “to deal with any unusual and extraordinary [foreign] threat … to the national security, foreign policy, or economy of the United States.” Pursuant to that authority, the President declared national emergencies with respect to malicious foreign cyber-enabled activities, and North Korea’s pursuit of its nuclear missile program.

After a national emergency is declared, the IEEPA authorizes the President to “regulate … or prohibit … any use [of], transfer [of], … dealing in, … or transactions involving, any property in which any foreign country or a national thereof has any interest.” Pursuant to that authority, the President blocked all property and interests in property of any person determined by the Secretary of the Treasury to have materially assisted, sponsored, or provided financial, material, or technological support for foreign malicious cyber-enabled activities that threaten the national security, foreign policy, or economic health or financial stability of the United States and the North Korean government.

The Secretary of the Treasury delegated the authority granted by Executive Orders 13694 and 13722 to the Director of the Office of Financial Assets Control (OFAC).

On November 8, 2022, OFAC designated “Tornado Cash” as a Specially Designated National or Blocked Person. The effect of the designation is that “unless licensed or otherwise authorized by [OFAC], (1) all real, personal, and any other property and interests in property of [Tornado Cash] … are blocked and may not be transferred, paid, exported, withdrawn or otherwise dealt in, and (2) any transaction or dealing … in property or interests in property of [Tornado Cash] is prohibited.”

The designation described Tornado Cash as

an entity with an organizational structure that consists of: (1) its founders—Alexey Pertsev, Roman Semenov, and Roman Storm—and other associated developers, who together launched the Tornado Cash mixing service, developed new Tornado Cash mixing service features, created the Tornado Cash Decentralized Autonomous Organization (DAO), and actively promote the platform’s popularity in an attempt to increase its user base; and (2) the Tornado Cash DAO, which is responsible for voting on and implementing those new features created by the developers.

The designation listed 91 Internet addresses that were affiliated with Tornado Cash, including the addresses for the “smart contracts” that Plaintiffs refer to as the “core software tool” of the Tornado Cash service….

Cryptocurrency is a virtual currency that can be used for payment or investment purposes…. Tornado Cash is a cryptocurrency “mixing service” that was founded by two Russians (Alexey Pertsev and Roman Semenov), Roman Storm, and other associated developers…. The Tornado Cash service uses smart contracts—which are essentially computer software created by its developers …. The smart contracts allow Ethereum users to deposit ETH [Ethereum coins] into a “pool” where it is mixed with other users’ deposits and then withdrawn at a time of the user’s choosing. The more users that have deposited ETH into the pool the more difficult it is to connect the withdrawal with a particular deposit, which thereby provides a degree of anonymity to the user’s transaction that is not available on the public ledger….

Tornado Cash transactions can be (and 84% are) executed with the aid of third-party “relayers.” The use of a relayer makes it even harder to identify the parties to the transaction, but transactions can be completed without a relayer….

The court also upheld the government’s actions against various other claims by Coin Center.

The government defendants are represented by Christine L. Coogle and Christopher Robert Healy of the Justice Department.

The Commodity Futures Trading Commission (CFTC) announced yesterday it had both filed and settled charges against three “decentralized finance” operations, Opyn Inc., ZeroEx Inc., and Deridex Inc. 

In the agency’s own language, the charges included “failing to register as a swap execution facility (SEF) or designated contract market (DCM), failing to register as a futures commission merchant (FCM), and failing to adopt a customer identification program as part of a Bank Secrecy Act compliance program” and “illegally offering leveraged and margined retail commodity transactions in digital assets.” 

The companies have to pay fines ranging from $100,000 to $250,000 and refrain from further such law violations. The full CFTC press release gives some of the technical details of the sort of decentralized “smart contract” operations the companies performed that the agency insists violated the law. Opyn, CFTC acknowledges, seemed aware it was legally questionable to offer its services to U.S. residents and tried to block them, but not hard enough in CFTC’s eyes.

The use of DeFi and smart contracts allows people to make sophisticated financial dealings involving buying, selling, trading, or swapping commodities, crypto, or derivatives more or less automatically without specific human entities having to make decisions and act. CFTC Director of Enforcement Ian McGinley says in the press release that, “somewhere along the way, DeFi operators got the idea that unlawful transactions become lawful when facilitated by smart contracts. They do not. The DeFi space may be novel, complex, and evolving, but the Division of Enforcement will continue to evolve with it and aggressively pursue those who operate unregistered platforms that allow U.S. persons to trade digital asset derivatives.”

In an intriguing Twitter thread yesterday, Delphi Labs general counsel Gabriel Shapiro, said this CFTC action ratifies what he’s long believed: DeFi is likely to be judged illegal in nearly all contexts interacting with U.S. citizens.

Shapiro advises that “if you run any kind of interface etc. for a DeFi credit protocol, block the U.S.,” adding, “I also always told you the CFTC would be an even worse regulator for crypto than the SEC.”

The underlying theory of this enforcement action, Shapiro says, is inherently anti-DeFi: “The purpose of DeFi is disintermediation. There is no way of making DeFi ‘comply’ with a mandatory intermediation regime—then it would not be DeFi, just intermediaries who use permissioned, KYC-gated etc. smart contracts as part of their tech stack.”

One CFTC commissioner, Summer K. Mersinger, filed a dissent to his agency’s actions. Among his complaints were that “we are asked [in this action] to find liability and impose sanctions based on a novel technology that was decentralized in conception and operation—an area that has not previously been the subject of a CFTC enforcement action.” Mersinger points out that “the Commission’s Orders in these cases give no indication that customer funds have been misappropriated or that any market participants have been victimized by the DeFi protocols on which the Commission has unleashed its enforcement powers.”

He thinks this represents a shift from a previous CFTC vow to use more “stakeholder engagement” and less out-of-the-blue enforcement actions in the DeFi space. “Yet, today’s actions do not promote responsible innovation—they shut it down, banishing innovation from U.S. shores.”

Mersinger points out that it would be often difficult or impossible for DeFi operations to legally register under CFTC rules as those rules “were written for centralized entities—are they fit for purpose if FCM activity can be performed in a decentralized manner?” He also asks, relevant to some of the specific charges at issue this week: “If a DeFi protocol is developed for lawful purposes but is used for purposes that violate the CEA [Commodities Exchange Act], should the developer be held liable?  Must the deployment and the illegal use be close in time, or is the developer of a DeFi protocol forever liable if its technology is used for illegal purposes by others?”

Overall Mersinger thinks these sort of enforcements “creates an impossible environment for those who want to comply with the law, forcing them to either shut down or shut out U.S. participants.”

As I wrote back in Reason‘s January issue, “DeFi’s ability to move value and make investment decisions via automatic, unregulated programming makes it harder for the government to rely on the old system whereby it drafts financial intermediators such as banks and brokers to spy on their customers.” The CFTC is acting on the eternal state imperative to crack down on anything that widens spaces where citizens can act without government knowledge and supervision.

From Van Loon v. Department of Treasury, decided Thursday by Judge Robert Pitman (W.D. Tex.):

This case is about Tornado Cash—but the parties disagree on how to characterize Tornado Cash. Plaintiffs contend that Tornado Cash is a decentralized, open-source software project comprised of a subset of smart contracts, or “pools,” on the Ethereum blockchain. In contrast, the government argues that Tornado Cash is an organization that runs a cryptocurrency mixing service. It is undisputed that the Department of Treasury’s Office of Foreign Assets Control added Tornado Cash to the Specially Designated Nationals and Blocked Persons (“SDN”) List. Plaintiffs argue that the designation exceeds the Department’s statutory authority over foreign nationals’ interests in property and violates the Free Speech Clause….

According to the government, cryptocurrency mixing services, known as “mixers” or “tumblers,” are designed to obscure the source or owner of particular cryptocurrency units, thereby allowing users to remain anonymous. A mixer customer typically directs mixer software to send a certain number of cryptocurrency units to a specific address that is controlled by the mixer, for a fee. The mixer then takes the sender’s cryptocurrency units and pools them together with the cryptocurrency of other users (i.e., “mixes” the cryptocurrency) before delivering the specified number of units to the requested destination. This renders it difficult to determine the link between a sender and recipient wallet account….

The International Emergency Economic Powers Act (“IEEPA”) authorizes the President to declare national emergencies “to deal with any unusual and extraordinary threat, which has its source in whole or substantial part outside the United States, to the national security, foreign policy, or economy of the United States.” Once a national emergency is declared, IEEPA authorizes the President to:

[R]egulate, direct and compel, nullify, void, prevent or prohibit, any … transfer … of, or dealing in, or exercising any right, power, or privilege with respect to, or transactions involving, any property in which any foreign country or a national thereof has any interest[,] by any person, or with respect to any property, subject to the jurisdiction of the United States[.]

Presidents have historically used this authority to impose economic sanctions on many countries, individuals, and entities, and those who provide support for malicious cyber-enabled activities…. On August 8, 2022, OFAC designated Tornado Cash pursuant to a [Presidential executive order]. The accompanying press release asserted that Tornado Cash “indiscriminately facilitates anonymous transactions by obfuscating their origin, destination, and counterparties, with no attempt to determine their origin.” OFAC noted that illicit actors often use mixing services like Tornado Cash to launder funds. The press release claims that Tornado Cash has laundered hundreds of millions of dollars’ worth of virtual currency since its creation in 2019, including hundreds of millions of dollars for the Lazarus Group, a North Korean state-sponsored hacking group. [Further factual details omitted. -EV] …

The court held that Tornado Cash was an entity that may be designated under the IEEPA:

The record shows that Tornado Cash is an association within [the] ordinary definition [of the term]. The entity is composed of its founders, its developers, and its DAO. The founders and developers “‘mostly do[ ] research and publish[ ] the code to GitHub.'” ). The DAO, on the other hand, is responsible for governing the platform, which includes “‘[a]ll deployments, protocol changes, and important decisions.'” Utilizing this structure, Tornado Cash has been able to place job advertisements, maintain a fund to compensate key contributors, and adopt a compensation structure for relayers, among other things. Substantial evidence supports the argument that founders, developers, and DAO constitute “[a] body of persons who have combined to execute [the] common purpose” of developing, promoting, and governing Tornado Cash….

Plaintiffs argue that Tornado Cash is not an entity but an autonomous software. However, as the Court notes above, OFAC identified both the software known as Tornado Cash and an entity formed by certain individuals. The record sufficiently supports OFAC’s determination that the founders, the developers, and the Tornado Cash DAO have acted jointly to promote and govern Tornado Cash and to profit from these activities….

The court concluded that “Tornado Cash has a property interest in the smart contracts,” and the court rejected plaintiffs’ First Amendment claims:

Plaintiffs argue that the government is prohibiting some of them from engaging in socially valuable speech because they, if not for the designation, they would use the Tornado Cash software to make donations to important political and social causes. Indeed, the First Amendment protects the right of individuals to donate money to social causes of their choosing. See, e.g., McCutcheon v. Fed. Election Comm’n (2014) (“The right to participate in democracy through political contributions is protected by the First Amendment, but that right is not absolute.”); NAACP v. Alabama ex rel. Patterson (1958). However, it does not protect the right to do so through any particular bank or service of their choosing, and Plaintiffs do not cite any case to the contrary.

In fact, Plaintiffs’ evidence does not sufficiently support their arguments. Plaintiffs claim that “[w]ithout the privacy afforded by Tornado Cash, users such as [Plaintiff] Almeida are hindered in expressing their views” of the Ukranian conflict. But Mr. Almeida’s affidavit does not describe such a hindrance, nor does it state that he has stopped donating to his preferred causes, that he would be unable to donate through other services, or that his speech has otherwise been chilled. Furthermore, Plaintiffs do not explain how the designation prevents them from using other services that may allow them privacy for their transactions.

Instead, Plaintiffs insist that the government may not interfere with their “liberty of expression … on the plea that it may be exercised in some other place,” simply because Plaintiffs “have alternate forums’ available to them.” While true, this principle applies primarily to public spaces. Tornado Cash, however, is not a public place or public forum; the cases Plaintiffs cite are inapposite.

Plaintiffs also claim that the designation chilled “the right to publish … source code,” which other circuits have held is protected speech. Similarly, amicus curiae Electronic Frontier Foundation argues that OFAC’s designation has had a chilling effect on certain code developers. However, OFAC’s designation blocks only transactions in property in which Tornado Cash holds an interest, such as the smart contracts. It does not restrict interaction with the open-source code unless these interactions amount to a transaction. Plaintiffs claim that using the code is impossible, since its sole function is to perform transactions. Plaintiffs’ characterization is misleading.

Developers may, for example, lawfully analyze the code and use it to teach cryptocurrency concepts. They simply cannot execute it and use it to conduct cryptocurrency transactions. Finally, to the extent that the designation could serve to create a chilling effect, Plaintiffs have not claimed, let alone sufficiently demonstrated, that any Plaintiff in this suit has felt inhibited to use the open-source code. Accordingly, the Court will grant summary judgment for Defendants on this claim….

“We have learned over the last few days that many small and mid-sized banks in this country are Zombies,” writes Arnold Kling, a senior scholar at the Mercatus Center at George Mason University and former economist for the Federal Reserve system and Freddie Mac.

Following the run on Silicon Valley Bank, former U.S. Treasury Secretary Larry Summers urged the federal government to guarantee the money of all the bank’s depositors and warned that “now is not the time for lectures about moral hazard.” But Kling insists that “past crises,” such as the savings and loan collapse of the 1980s, “were bungled by authorities who were blind to the moral hazard problem.”

And Lyn Alden, founder of Lyn Alden Investment Strategies, says “banks are basically highly-leveraged bond funds with payment services attached, and we treat it as normal to keep our savings in them.” She argues that the Federal Reserve makes it nearly impossible for banks to hold the bulk of their customers’ deposits in cash because “regulators want banks to be reasonably safe, but not ‘too safe.’ They want all banks to be leveraged bond funds to a certain degree, and won’t allow safer ones to exist.”

Join Reason‘s Zach Weissmueller this Thursday at 1 p.m. E.T. for a discussion about the federal government’s decision to guarantee all deposits at the failed Silicon Valley Bank with Alden and Kling. Watch and leave questions and comments on the YouTube video above or on Reason‘s Facebook page.

Photo credit: Shen Hong / Xinhua News Agency/Newscom

Today’s Reason Interview podcast has double the hosts and double the guests.

Every Thursday at 1 p.m. Eastern, Zach Weissmueller and I host a live interview on Reason‘s YouTube channel. Today’s episode is pulled from our recent conversation about government regulation of cryptocurrency and related matters that we had with Hester Peirce, a renegade commissioner at the Securities and Exchange Commission (SEC), the Depression-era agency whose task it is to supposedly “protect investors,”  “maintain fair, orderly, and efficient markets,” and “facilitate capital formation.” 

When the SEC recently fined the cryptocurrency exchange Kraken for supposedly offering an unregistered security, Peirce publicly broke with her colleagues, denouncing the decision as “paternalistic and lazy” and sadly representative of the government’s unwillingness to issue clear regulations governing bitcoin and other cryptocurrencies. We talk with Peirce, who used to work at the Mercatus Center at George Mason University, about why she believes the SEC is overreaching when it comes to crypto regulations and what good regulations might look like.

In the second half of the show, we’re joined by Nic Carter, a partner at Castle Island Ventures and a leading proponent of blockchain technology and the crypto future. He talks about why he didn’t invest in Sam Bankman Fried’s FTX and how the crypto industry needs to do more to police itself from fraudsters, whose inevitable collapse makes it more likely government will step in with terrible, soul-and-commerce-crushing rules and restrictions.

Today’s sponsor:

• The Reason Livestream. Every Thursday at 1 p.m. Eastern, Nick Gillespie and Zach Weissmueller host live, unscripted conversations at Reason‘s YouTube channel with leading policymakers, activists, writers, and thinkers about everything from attempted internet censorship to Covid-policy failures to the future of the Libertarian Party to cryptocurrency crackdowns to the failure of K-12 education. Online archive here.