The fall-out from sanctioning continues to unfold and could impact bitcoin
The U.S. Treasury Department sanctioned Tornado Cash on August 8, 2022, alleging that the tool lets users send and receive crypto anonymously, laundered more than $7 billion worth of crypto assets since 2019. The measures banned all U.S. residents and entities from using Tornado Cash. Before Aug. 8, the Treasury had never sanctioned an open source protocol.
That move by the U.S. Treasury Department has started a wave of reactions as dapps and protocols try to navigate the mess left behind, and best serve the interests of their platforms and users. At the same time, some ponder the eventual ramifications for Bitcoin. However, not all decision-making and ideas are greeted with open arms as arguments about decentralization and centralized control come to the fore again.
All this amidst a bear market and core DeFi platforms like Curve announcing further decreases in demand for cryptocurrencies from whale and institutional investors. According to data from Dune Analytics, Curve recorded approximately $8 billion in volume throughout July, which is a 48% decrease from June. Aside from Curve, other notorious high-volume DEXs such as Uniswap, Synthetix, Balancer, Shibaswap, and Sushi have also fallen to new lows as investors’ confidence continues to shake.
Actions need reactions
After the ban took effect, Centre, which is the consortium behind USDC, blacklisted 38 wallet addresses and froze the $75,000 in USDC they held. The consortium, set up by Circle and Coinbase, has banned 81 wallet addresses since the launch of USDC in September 2018.
The blacklisting of Tornado Cash wallets brought the decentralization of MakerDAO’s DAI stablecoin into focus mainly as industry observers already criticize DAI as nothing more than wrapped USDC. Because DAI is 32% backed by the USDC stablecoin. That is the equivalent of about $3.5 billion and means it’s the single-largest asset backing DAI.
Moreover, observers are concerned about DAI’s dependence on USDC, which is, in essence, a centralized asset inclined to interference from government and corporate ideas.
Two weeks ago, MakerDAO announced speculative plans to swap up to $3.5 billion in USDC for Ethereum — a move that could result in its DAI stablecoin losing its dollar peg. Currently, there is more than $7.6 billion DAI in circulation, making it the fourth-largest stablecoin by market capitalization.
DAI could potentially de-peg
DAI is an overcollateralized stablecoin, which means users looking to hold DAI need to provide assets from a range of cryptocurrencies into the MakerDAO protocol as collateral to maintain DAI’s peg to the dollar. Unlike USDT or USDC, which are both controlled from a central point. DAI is considered to offer unparalleled decentralization because of the lack of a central authority.
The problem is that DAI’s peg to the dollar is maintained by what is known as Peg Stability Module (PSM), which allows users to swap stablecoins such as USDC on a one-to-one basis in exchange for DAI.
With more than 30% of the collateral backing DAI comprising USDC, selling means fiddling with the pegging mechanism. But without arbitrage to maintain the dollar equivalence, DAI would ultimately depeg and rise above $1.
The founder of MakerDao, Rune Christensen, believes that the rewards outweigh the risks and mostly vents concerns about how the Tornado Cash issue demonstrated a way to quickly and unconstitutionally stop any smart contract attached to centralized stablecoins with no lead time to take actions. In a nutshell, MakerDAO wants to reduce its dependency on an asset that can potentially be meddled with by outside parties.
Vital to note is that Rune Christensen and MakerDAO will still need to put this proposal to a vote, and nothing has been decided yet. Ethereum founder Vitalik Buterin commented on the situation, stating that MakerDAO’s plan to sell $3.5 billion USDC for ETH could be risky and terrible. He further stated that he thinks one solution might be limiting the weightings of any asset used as backing to around 20%.
As USDC gets battered by constant negative media chatter and the apparent bending to adhere to lawmakers’ requests, DeFi maximalists started to look outside the list of the top three stablecoins of USDC, USDT, and BUSD.
With AAVe and Curve announcing stablecoin projects this year, competition is only getting more fierce. However, some industry spectators doubt investors will leave the top three behind before more information and clarity arises.
However, investors are exploring alternatives such as Liquity, a protocol that relies on collateralized debt positions. LUSD has been gaining favor as a more decentralized option since Liquity only accepts ETH as collateral. According to DEX Screener, they have seen their USD-pegged LUSD jump to $1.04. While industry influencers, Tetranode are talking about RAI, which isn’t pegged to USD but is backed by just ETH and designed to maintain a stable price.
Synthetix also has its sUSD stablecoin, and some community members feel it can start to take market share, given the decreasing trust levels in USDC and the top centralized stablecoins.
How far can the lawmakers go?
There is arguably no limit to what enforcement agencies such as the Treasury Department’s Office of Foreign Assets Control can do to reach their goals. Which arguably has now been laid bare by the Tornado Cash debacle. The case is even more interesting because many decentralized tools were built in response to governments’ overarching control in the first place and have been designed to prevent such actions.
As emphasized by numerous industry players over the last few weeks, the sanction of open-source code could infringe on the Constitutional First Amendment, which protects freedom of speech. More importantly, code was established as speech under U.S. law. Moreover, any attack on open-source code is an attack on Bitcoin.
Additionally, the complete sanctioning of Tornado Cash has negative implications for law-abiding residents that used the tool to protect their legitimate privacy interests. Moreover, It led to people questioning whether The US Treasury Department could extend the measures to Bitcoin and its tools.
Bitcoin has mixers
Bitcoin has its mixing tools called CoinJoins. These are a method of mixing coins to protect users’ privacy on a public ledger like bitcoin. There are also tools such as Samourai and Wasabi. Assuming that enforcement agencies can extend their authority to fit their requirements, these could come under fire from sanctioning threats.
The first scenario is an enforcement agency banning CoinJoins altogether. However unlikely, and while it would mean excluding multiple-party Bitcoin transactions, such an action can still be done.
Perhaps a more likely scenario is CoinJoins’ coordinators being sanctioned. While platforms like JoinMarket wouldn’t be straightforward to sanction due to their setup, in the cases of Samourai and Wasabi, there are central coordinators. This type of sanction is still relatively unlikely given the structure of CoinJoins and because of a statement by Europol saying that Anti Money Laundering rules don’t apply to these tools.
In theory, sanctioning coordinators would be similar to the sanctioning of Tornado Cash, but in practice, it’s different. With Bitcoin CoinJoins, there is no single point of contact to the Bitcoin blockchain, which is a crucial difference from Tornado Cash’s smart contract system based on Ethereum. But of course, everything is possible.
Another key difference between Bitcoin and Ethereum is that in the Ethereum ecosystem, centralized tools play a more significant role in its decentralized workings. For example, Infura, which powers most Ethereum dapps, wallets, and services, is susceptible to sanctions and censorship. Arguably, bitcoin is much better positioned to sustain similar problems.
Given its design, Bitcoin is arguably the most well-prepared network to withstand attacks from the state. Moreover, challenges to implementing possible sanctions on Bitcoin privacy tools make action unlikely and relatively useless. Finally, the unique characteristics of CoinJoins and the differences in their work mean the likelihood of such an event is low.
The above does not constitute investment advice. The information given here is purely for informational purposes only. Please exercise due diligence and do your research. The writer holds positions in various cryptocurrencies, including BTC, ETH, and RADAR.