The Breakdown - The Arrest Heard Round the World

Episode Date: August 16, 2022

This episode is sponsored by Nexo.io, Chainalysis and FTX US.   On today’s episode, NLW looks at the crypto industry’s response to news that 29-year-old Alexey Pertsev was arrested for his work on Tornado Cash. He also looks at Coin Center’s new potential court challenge to the Office of Foreign Asset Controls sanctions, which argues that the agency doesn’t have the authority to sanction a smart contract in the first place.  - Nexo is a security-first platform where you can buy, exchange and borrow against your crypto. The company safeguards your crypto by relying on five key fundamentals including real-time auditing and insurance on custodial assets. Learn more at nexo.io. - Chainalysis is the blockchain data platform. We provide data, software, services and research to government agencies, exchanges, financial institutions and insurance and cybersecurity companies. Our data powers investigation, compliance and market intelligence software that has been used to solve some of the world’s most high-profile criminal cases. For more information, visit www.chainalysis.com. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - I.D.E.A.S. 2022 by CoinDesk facilitates capital flow and market growth by connecting the digital economy with traditional finance through the presenter’s mainstage, capital allocation meeting rooms and sponsor expo floor. Use code BREAKDOWN20 for 20% off the General Pass. Learn more and register at coindesk.com/ideas. - Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsors is “The Now” by Aaron Sprinkle. Image credit: Chalermphon Kumchai/EyeEm/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

I think what is resonating so much with people about this particular case now, especially with this arrest, is that it really does get to fundamental questions of privacy in a digital world, and whether the cost of criminals being able to use technologies for nefarious purposes is worth undermining that privacy in fundamental ways. This is the ever-present question of power as it relates to the Internet. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.com, and FTCS, and produced and distributed by CoinDesk.

What's going on, guys? It is Monday, August 15th, and today we are talking about the arrest heard around the world. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rate, leave it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also, a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. So last week, the biggest news by far was around the sanctioning of tornado cash by the U.S. Treasury Department's Office of Foreign Absets Control. What made this different than previous times that U.S. sanctions had come to the crypto industry

is that rather than sanctioning some specific set of addresses tied to specific actors who were engaged in what the U.S. accused of illicit behavior, these sanctions seem to apply to an entire protocol. Effectively, it was the smart contract itself that was being sanctioned. This obviously generates huge questions. Can a smart contract even be sanctioned? What's going to happen to all of the people whose addresses have previously interacted with tornado cash in some way, even for non-elicit purposes? What would happen if someone decided to go spam publicly known wallet addresses with tornado cash transactions? Would they then be in violation of sanctions? Et cetera, et cetera. Now, a lot of the discussion last week focused on two things.

The first was the practical ability to enforce these sanctions. Would we just see tornado cash copycats come up instead? Would any address that had previously interacted with Tornado Cash now be blacklisted from other defy applications? And of course, there were the larger industry questions of what it means in terms of privacy and decentralization. How decentralized really are these protocols if they're all going to comply with U.S. sanctions? And what are the underlying principles of privacy that we want to build into our new crypto-powered systems? Is there an enough privacy that's different from a full mixing service? Is the principle of privacy such that it doesn't matter that a technology can be used by these bad actors? In other words, that that's not too much of a

price to pay. These were all of the questions that were swirling, but one additional question was what was the status of the developers who had contributed to the protocol? Were they also sanctioned? Were they just tainted by association? Were they somehow fine? Well, on Friday, news broke that the Netherlands had arrested a 29-year-old developer in Amsterdam in conjunction with his work on tornado cash. The Netherlands fiscal information and investigation service, FIOD, issued a statement that said, on Wednesday, August 10th, the FIOT arrested a 29-year-old man in Amsterdam. He is suspected of involvement in concealing criminal financial flows and facilitating money laundering through the mixing of cryptocurrencies through the decentralized Ethereum

mixing service tornado cash. Multiple arrests are not. not ruled out. These advanced technologies, such as decentralized organizations, that may facilitate money laundering, are receiving extra attention from the fiat. The statement goes on to argue that tornado was offered by a Dow, which was, as many was quick to point out, not true. The other important part of the Dutch statement was this line. It is suspected that persons behind this organization had made large-scale profits from these transactions. Many in the community pointed out that because there are no fees associated with tornado cash, it's not clear that that's true. Pretty soon, Twitter started suggesting that the arrested developer was Alexei Pertsev,

and by the middle of the day, that fact had been confirmed by his wife. The response on crypto Twitter was deafening in roughly exactly what you'd suspect. Bankless's Ryan Adams wrote, They arrested the developer of Tornado Cash. I repeat, a man was arrested for writing code that served as a public good for people to maintain their privacy online. They put a man in jail because bad people used his open source code. This cannot stand in any free society. Investor Adam Cochran writes,

What the hell? We'll need to hear more of the specifics, but this is insane. Code is free speech. Unless there is more to this story than arresting someone for making a privacy tool that was misused is an insane government overreach. Privacy is under assault. Jake Chivinsky writes, we should all be closely watching the situation in Amsterdam, where a tornado cash developer has been detained.

It's unclear if there are allegations of illicit conduct unrelated to writing code. If not, this threatens to be the start of Crypto Wars 2. Greg Osuri, the founder of Akash Network, writes, arresting an open-source privacy software developer because his code was used for money laundering is like arresting Edison for war crimes because his bulb was used by the Nazis. I better hope there are other charges. If not, this arrest is a direct assault on free speech.

Stanley, the founder of AVE Protocol, writes, getting arrested for writing privacy-preserving code is out of line. This arrest makes all privacy and encryption developers a target. The worst part is people use privacy tools on a daily basis online because the internet is an unsafe place without privacy or encryption. Richard Ryan, the co-founder of Black Rifle Coffee, writes, where does it stop? Arrest Andy Rubin for fraud that happens on Android devices? Industries of monetary policy and speech are being disrupted.

Traditionally, if there is no incentive for those who benefit from maintaining the status quo, they seldom give up that power without struggle. Now, these types of analogies were a really common theme. Because, of course, it is the analogies and the implications of this that suggest such huge overreach. Bantig writes, Breaking. A founder of a gun-making company is arrested for facilitating a public shooting. A founder of a knife-making company is arrested for facilitating a stabbing.

A founder of a pressure-cooker-making company is arrested for facilitating a public shooting. terrorism. A head of Treasury is arrested for facilitating money laundering. Everyone holding cash is now sanctioned by OFAC. DGNRoute, a crypto investor at Outlier Ventures, writes, with a suspected tornado cash developer now arrested in the Netherlands, dangerous precedent is now taking root. I cannot state this enough. This is a pivotal moment in our industry. This can have huge consequences for the Web 3 decentralized industry in general. Now, it's worth noting, obviously here, that a huge part of this discussion is around free speech. But of course, this arrest happened in the Netherlands, not the United States. The arrest was by Netherlands authorities and under Dutch-Slas EU law.

The EU does have a convention on human rights. Clause 1 reads, Everyone has the right to freedom of expression. This right shall include freedom to hold opinions and to receive and impart information and ideas without interference by public authority and regardless of frontiers. However, there is no analogous precedent on whether Coda's speech like in America. So is it a violation of established free speech protections in the country where the arrests occurred? Not exactly, but it brings up that in internet world, the importance of precedent, of legal precedent when it comes to whether code is speech is going to get more or not less important. Ultimately, Alpavie, a researcher at Element put it really well, saying,

holy shit, I'll be real. I think what I'm working on is cool and important, but not go to jail important. Chilling effect on the space is going to be real. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted partner by your side. Nexo is a security first company that manages risk by relying on mechanisms such as over-collateralization, real-time auditing, and insurance on custodial assets. Learn more about Nexo's reliable business model and start your crypto journey. at nexo.io. That's nexo.io. Eager to make more informed decisions around crypto, chain analysis is here to help. Chainllysis demystifies cryptocurrency by providing industry-leading

compliance, market intelligence, and investigations support for all crypto assets. For organizations like Gemini, crypto.com, and BlockFi, gain unparalleled visibility and maximize your potential with the leading blockchain data platform by visiting us now at chainalysis.com slash coin desk. The breakdown is sponsored by FTXUS. FtXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTX, you pay no gas fees.

Download the FTX app today and use referral code breakdown to support the show. Now another part of this story that we flagged last week was the application of these sanctions. And over the course of the week and weekend, we got a bit more color there too. On Wednesday, on-chain derivatives platform, DYDX began blocking all users who had interacted with tornado cash after the sanctions were announced. On-chain lending protocol, Ave implemented the same restrictions on Friday. Decentralized exchange uniswap and automated market maker balancer followed soon afterwards. Now, many found these actions particularly troubling in light of a dust attack on Wednesday, where an anonymous tornado cashed users sent small transactions from tornado cash to numerous public wallets.

Peckshield reported that as of Saturday morning, over 600 addresses had been affected. For example, Tron founder Justin Sun was blocked from Ave on Friday due to receiving a small amount of ETH from the attack. For many, this is highlighting another new systemic risk issue. The automated blocking of users with large open positions in defy applications could be hugely problematic. Now, some do think that protocols are at least a little bit overreacting because of the scariness of jail time when it comes to sanctions. Victor Bunnan from Coinbase writes, what we're seeing now in the industry is extreme overreaction. teams are confused about what we do when it comes to compliance. I understand the fear, but my ask is as follows.

Seek experienced legal counsel to deeply understand the issues before taking rash actions. Web3 is not against regulation, but it's important that regulation is implemented and followed in ways that accomplish the right goals in a sustainable manner. Slow down and let's get this right together. Some protocols have been trying to adjust. DoIDX tweeted, we were recently made aware of an issue related to Tornado that was causing many wallet addresses to be blocked from accessing our exchange. We have rectified this. Many accounts were blocked because a certain portion of the wallet's funds, in many cases,

even immaterial amounts, were associated at some time with tornado cash, which was recently added to the sanctions list by the U.S. Treasury's OFAC. This sudden influx of flags affected many account holders that never directly engaged with tornado cash, and often such users do not realize the origin of the funds transferred to them during various transactions prior to interacting with our platform. We've made adjustments within the limits of our compliance policies that of unbanned certain accounts and will continue to try to limit flagging and track this moving forward. Still, this accusation of overcompliance hangs over the industry. Vincent Van Doe tweeted to see all of the top quote-unquote decentralized protocols

tripping over themselves to over-compli. The speed at which everyone is falling into line will emboldened governments to continue down this path in an increasingly heavy-handed manner. Have we no fight in us? Well, when it comes to looking for a fight, one of the actors that's most on it is CoinCenter. This morning, they updated their analysis around the problems with OFAC's action and suggested that they were exploring a court challenge. Summarizing the shift, Peter Van Valkenberg writes, rather than leap to constitutional arguments, we start with statutory authority claims

that can be buttressed with looming constitutional issues, but are also strong under plain meaning of the International Emergency Economic Powers Act. From CoinCenters analysis, quote, The statutory manner in question is not an American's ability to get a license to use the tool, but rather the fact that adding a mere tool to the list, rather than adding an entity or the property of an entity, was outside the legal authority of OFAC under the IEPA, the International Emergency Economic Powers Act, to begin with. Even if a general license was granted in this specific case, there would be no legal way to stop OFAC from simply adding new non-property, non-entity designations beyond the Tornado Cash application to the OFAC list in the future, despite there being questionable

statutory grounds for such unprecedented sanctions. OFAC could incautiously add all manner of non-proprietary software tools to the list, eGPGP software for email privacy or even the entirety of Bitcoin itself, and then they could create a de facto licensing regime to selectively allow Americans to once again use these tools. This would be a very powerful tool for social control, and it seems divorced from the tax and purpose of the underlying statute upon which OFAC's authority is based. Speaking generally, IEEPA allows the president to block U.S. persons from dealing in the property of a foreign national. It is not a regime for dictating what types of software, books, music, or tools Americans should be able to use. As we suspected, we believe that OFAC has overstepped

its legal authority by adding certain Tornado Cash-smart contract addresses to the SDN list, that this action potentially violates constitutional rights to due process and free speech, and that OFAC has not adequately acted to mitigate the foreseeable impact its actions would have on innocent Americans. We intend to work with other digital rights advocates to pursue administrative relief. We are also now exploring bringing a challenge to this action in court. Obviously, I am hugely supportive of this challenge from Coin Center, but I also agree with Tor Blair from the Secret Foundation,

who made a great point about why, to some extent, these sort of legal challenges are cold comfort in the short term. Quote, even if all this ends up getting overturned in courts years down the line, and it's clear this was overreach, and it's still unclear right now whether that would be the outcome, what happens in the intervening years has real consequences to people who are in these systems, especially as of this morning with the arrest. That can happen regardless of whether or not this is overreach. That is happening today. The consequences are current. I think what is resonating so much with the arrest is. I think what is resonating so much with people about this particular case now, especially with this arrest, is that it really does get to fundamental questions of privacy in a digital world, and whether the cost of criminals being able to use technologies for nefarious purposes is worth undermining that privacy in fundamental ways.

This is the ever-present question of power as it relates to the internet. Indeed, it is perhaps the single most important question, as relates power on the internet. An inherent property of digital technologies is that they create more trackable and traceable footprints. That creates an unbelievable surveillance honeypot for governments. So in the end, there are two recourses for people who want to use tools privately. Either one, its new types of privacy preserving technologies, or two, it's fight legal and political battles to have the value, of privacy enshrined in the context of this very new environment. The good news, if you listen to my conversation with Jill Gunter last week, is that this is far less binary than it seems, and that there

is a wave of new privacy technologies that have the potential to both achieve personal privacy goals as well as compliance goals. But it feels important that the underlying principle of privacy is reaffirmed over and over again. Otherwise, there will always just be another battle down the line. On Friday, Zuko, the founder of Zcash posted, Today is a good day for everyone to post this. The image with his tweet says privacy is normal. Privacy is for good guys. It's for moms and bike messengers and foodies. Privacy is for business meetings and voting booths. It's why we have shower curtains. It's why we have that little padlock icon in our browser bar. Privacy protects you from discrimination and from identity

theft, and it keeps your food delivery history under wraps. It can also shield you from those creepy somebody has definitely been listening to my thoughts ads on social media apps. Privacy isn't about shutting out everyone and everything. Instead, privacy gives you the power to choose what and with whom you'll share. It provides safety, control, and the right to grant access. Privacy gives you the ability to express yourself, to be creative, to spend your time and your money in whatever manner you like, without the scrutiny of others. It protects our intimate moments, our most embarrassing ambitions, our radical ideas, and the ability to be our true selves. Privacy is freedom, consent, dignity, and security. Privacy is normal. I want to say thanks again to my sponsors nexto.com,

chain aliasis and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.