Unchained - Is This the End of DeFi? Why the US Government Is Going After Tornado Cash - Ep. 536

Starting point is 00:00:00 There is nothing inherently illicit about wanting to keep your transactions private. Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I'm your host, Laura Shin, author of The Cryptopians. I started covering crypto eight years ago, and as a senior editor at Forbes, was the first mainstream media reporter to cover cryptocurrency full-time. This is the August 25th, 20203 episode of Unchained. Today's episode is brought to you, by overtime markets, your premier web3 sportsbook. The innovative protocol is changing the game one match at a time. Powered by Thales, explore more at overtimemarkets.xy-Z. Arbitrum's leading layer-2 scaling solution offers you ultra-cheap and lightning-fast transactions, all with security

Starting point is 00:00:48 rooted on Ethereum. Visit arbitram.io today. With the crypto.com app, you can buy, trade, and spend crypto in one place. Download and get $25 with the code, Laura. link in the description. Today's guest is Amanda Tuminelli, chief legal officer at Defi Education Fund. Welcome, Amanda. Thank you. Thanks for having me on.

Starting point is 00:01:12 Last summer, the U.S. government sanctioned the Tornado Cash Smart Contracts. At the time, many people in crypto said that it didn't make sense to sanction software and that the government had made a mistake. But this Wednesday, the government actually went a step further. What happened? On Wednesday, the, Southern District of New York indicted Roman Storm and Roman Seminov for three different counts of

Starting point is 00:01:35 conspiracy. And we can get into what those charges actually say. But at bottom, they're saying that between 2019 and 2022, the three co-founders of Tornado Cash created software that the government is saying was used to commit various crimes. Yeah. One of the comments made here was that they facilitated more than $1 billion in money laundering. Does that make sense to you? You know, lot of people in crypto, at least, make a distinction between developers and the actual software in crypto, which is, you know, as people tend to describe as decentralized. So what's your take on whether or not, you know, facilitated really is the right word? Yeah. And I think that they're, just to hinge off of something you said, they should be making a distinction between software

Starting point is 00:02:24 development, right, and alone and doing more than that. And I think here in the indictment what we're seeing as an allegation that the conspiracy to commit money laundering from September 2020 to August 2022 is the creation of the software that allowed various people all over the world to use it to anonymize private transactions. And I think that we haven't seen this exact set of circumstances come up before. And I think the question of whether facilitation is the right word also comes into play with the money transmitter allegations, which we can also talk about. But for the money laundering charge, it's really my guess to give the government the benefit of the doubt. I think what they're going to say is it's really more about the concealment of potential proceeds of a crime versus like the

Starting point is 00:03:16 facilitation of that crime. And when you say concealment of proceeds of a crime, what do you mean by that? Like who who's doing a concealing? So I think what the, you know, these are all unprecedented. of course. I think what the government would say in this indictment is that the agreement, right, because this is a conspiracy charge, not the actual substantive charge itself. So they're saying that there was an agreement between several people to knowingly engage in conduct that might be money laundering. I think that they're saying that the agreement was to provide software that would conceal transactions that include criminal proceeds. I think that's what the government would say. and that the money laundering charge in this case is actually not hinged on like the money

Starting point is 00:04:04 transmitter business or the IEPA violation. It's actually connected to the cyber crime fraud and abuse act and the wire fraud act. So I think what they're going to say is the tornado cash founders told everybody they had no control over this protocol when in fact they did. And of course we would disagree with that, I think. But the government's going to say they told the world that they, They had no control over this protocol, which allowed people to anonymize transactions when, in fact, they did. And then that protocol was used by Lazarus Group to engage in the Ronan hack.

Starting point is 00:04:39 And the Tornado Cash founders have, like, essentially agreed to allow the service to continue concealing those proceeds. Now, I think a more rigorous understanding of the technology would not support those allegations, but that's, I think, what the government would say. And what then would be the view you have based on how the technology works? So I think that we have to look carefully at what tornado cash smart contracts were actually doing. And I think the keywords here are, you know, when it comes to the money, transmitter business allegations specifically are accept and transmit. I do not think that the tornado cash software was accepting people's funds and transmitting them to other people. If we are looking specifically at the technology, the smart contracts were

Starting point is 00:05:29 publishing secret notes that one person intended to send to the network, and they were publishing those secret notes to the actual smart contract protocol. So I don't think that is the same thing as saying that they are accepting and transmitting funds or accepting custody or holding any funds on behalf of customers. I think that we need to make that distinction when we're talking about the technology. Storm's lawyer, Brian Klein, said, quote, we are incredibly disappointed that the prosecutors chose to charge Mr. Storm because he helped develop software. And they did so based on a novel legal theory with dangerous implications for all software developers. What is that theory that they used to make the arrest and what do you think the implications are for all software developers?

Starting point is 00:06:19 So, yeah, I think that the novel theory here is the money, transmit or business theory that they're alleging and count to of the indictment. I think that we have not seen an indictment package together, user interface, smart contract protocol, and, you know, what the government is going to say marketing and promotion of services and call it a service so that they can call it a business so that they can then say it's a money transmitter business. I think we have not seen that before. And as Brian said, and Brian is an amazing lawyer, and we should always listen to him when he's when he's talking about criminal defense cases. But he, I think what he's, the point he's making is from Storm's perspective, he developed this software. And just because he developed this

Starting point is 00:07:07 software and some other person in the world used it to do something bad, Storm should not be held responsible for simply putting that software out into the world, right? That is not, that is not there that would have huge ramifications for all software developers everywhere. You can use anything, you know, to commit a crime. So I think that there is a really big chilling effect that could happen if this kind of theory is like extrapolated out. Yeah, I mean, this really strikes at the core of decentralization, which is, you know, one of the foundational principles of the crypto movement. And I just wonder, you know, looking at this, do you know, think that if this kind of charge by the government stands, if, you know, decisions kind of affirm

Starting point is 00:07:55 what the government is alleging here and that it is criminal, do you think that means the end of defy? I don't think that means the end of defy. I was hoping you would ask me this so that I could say this. I do not think it means the end of defy. I have seen a lot of really some anxiety on Twitter. Obviously, I think everybody is up in arms and I totally get it and is very serious when we are alleging liberty interest related allegations, right? But I do not think this is the end of defy. I think that we need to be clear about what the indictment is saying and what it is not saying. It is not saying that simply running a front end is a crime. It's not saying that simply writing code is a crime. It's saying that according to the government, that you're running a financial

Starting point is 00:08:41 institution that would have to comply with the Bank Secrecy Act. And when you agree to do that thing and you don't actually comply, that is the crime. So I think that that is, I think the indictment is just a little more specific about what they're criminalizing. And I think that's a good thing for Defi, right? We don't want the indictment to be broader than it actually is. We want it to be as specific as it possibly could be in terms of differentiating what is going to be pursued as a crime versus what is not. In a moment, we're going to talk a little bit more about what this could mean for Defi, But first a quick word from the sponsors who make this show possible. Arbitrum stands at the forefront of innovation as the premier suite of layer two scaling solutions,

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Starting point is 00:10:11 Overtime supports over 40 leagues and utilizes advanced smart contracts to ensure a seamless user experience. Discover the future of sports trading at overtimemarkets.xyz. Back to my conversation with Amanda. So based on this, do you think we're going to end up in a world where all front ends will need to do know your customer processes? Fair question. I think that that is where my brain would go first, right? Like that does seem to be the logical conclusion of what the indictment allegations are saying, but I don't think that that's where we have to go. I think that that is not necessarily what's going to happen. I think that there is a risk analysis to be done for every project.

Starting point is 00:10:53 Like if you are putting out a protocol connected to a front end, you have to analyze whether there is a risk of sanctions violations, a risk of AML violations, and take action in response to that risk. And I think, obviously, getting a lawyer involved is always a good idea to help you do that assessment. But I don't think that this has to mean that we're just going to regulate. all front ends going forward. I also think we should separate out, this is the DOJ. This is not Treasury, right? This is not the Department of Treasury. This is not OFAC. This is the Department of Justice alleging criminal allegations. So we should separate out like forward looking regulation from what the DOJ is doing by putting out an indictment. Yeah. And that's a natural, natural segue to my next question, which is about a blog post that CoinCenter published pointing to some FinCEN

Starting point is 00:11:47 guidance, where they say that they believe that these charges actually run counter to that guidance. I think this goes back to some of the comments you were making earlier about the custody. Can you explain CoinCenter's argument and also talk about whether or not you think this could be a potential defense for these developers? Yeah, absolutely. And I thought the CoinCenter piece was really on point and talking about how the industry had this 2019 FinCEN guidance that it felt was like actually pretty clear at the time, which is if you're running an anonymizing software provider, you are not a money transmitter business. And I think it is surprising to have received that guidance and then see this indictment come out and think, wait, like, how is that consistent

Starting point is 00:12:32 with what this guidance said several years ago? So I think that the article does a great job of explaining how that guidance would have made software providers who created tornado cash think that what they were doing was providing software alone and not running a money transmitter business. And it is on the theme of, you know, this regulation by enforcement atmosphere where instead of getting prospective advice, we're finding out after the fact that people did things wrong. But I think that what I was saying earlier with the accept and transmit is like that's the key question when we're talking about running a money transmitter business. is the alleged business or group of people accepting funds and transmitting them.

Starting point is 00:13:14 And I think here when you look at the actual software, what it's doing, it is not accepting funds and like holding them and then transmitting them to other people. I think that's a mistake on the tech. You know, one thing I can't help but notice is people are reacting very strongly to these charges, same way that they did last year regarding the sanctions on tornado cash. However, you know, both of these actions by the government seemed to have happened basically because North Korea was involved. And this was a theory that Airy Redboard had put, you know, given on the show last year. And I wondered, you know, if you thought that that continued to just heighten

Starting point is 00:14:02 you know, the government's radar on anything going on in crypto when we see that, you know, those actors involved. 100%. I think that they're the specter of the involvement of North Korea is very strong here. And I think it's what the case will look like what they will use to make the case look really bad to the jury, right? It's like you say North Korea and everybody has a strong reaction. I also think you see this theme.

Starting point is 00:14:32 in the indictment that is like very anti-privacy, anti-encrypted messaging apps, anti-you wanting to keep your transactions private, right? Like I think that it is like part of this package of we're going to make this look as bad as we possibly can because they want to convince the jury that there were crimes committed here. And in order to do that, they have a high burden and they need to meet that burden. So they're going to use, I think, the tools that they have in their arsenal to make it look really bad. And so what would you say these indictments mean for anybody in crypto who's working on privacy? I would say that privacy is not illegal or illicit. And there is nothing, you know, of course this is not legal advice, but there is nothing inherently illicit about using encrypted messaging apps. There is nothing inherently illicit about wanting to keep your transactions private. I've seen so many memes about how like cash is the original way of keeping your transactions private, right? The government can't surveil your cash transactions. And what we're seeing is like the government chip away at this idea.

Starting point is 00:15:36 that we as citizens want to keep our transactions private. So I would not say, like, give up. I think that there are other ways to fight. And just because we've received like one indictment, that does not mean we don't continue to educate lawmakers and policy makers and look at like the policy side of this world as a place where we can make more headway in favor of privacy rights. And, you know, we've seen multiple instances where North Korean hackers do use the tools of defy and other, you know, blockchain related things to enrich the North Korean dictatorship. So I wondered what advice you would have for developers in crypto who are working on decentralized projects. That's tough. I don't, I'm just a litigator. I don't typically give

Starting point is 00:16:27 perspective advice to projects, but what I would say is it is all about a risk analysis. And I know that it is costly and kind of annoying to get a lawyer involved in your project early, but I think in part it is smart to do a risk analysis and understand what risks you need to mitigate in order to operate because I think we are all trying to create enough room for technology to be able to flourish and for people to be able to innovate. So I think you have to do that risk analysis early and get the best advice you can. All right. And so in regards to this case, what are next things you're you're looking for? One of the developers was arrested, a storm. Seminov, I think, is still living freely. But, you know, what do you think the next steps will be?

Starting point is 00:17:17 Sure. So this just begins the process, right? We're at the very beginning. There will still be time for motion practice and discovery and eventually if we get their trial. So I think the very next thing that we'll see happen is Roman Storm. will have to be arraigned on the indictment, enter a plea of either guilty or not guilty. And then there will be some kind of bail hearing and argument related to that to determine whether or not he is going to be able to be out during pretrial release or whether he'll be held. So I'm sure Brian will be very focused on that in the next few days. But then after that, it's motion practice. So what any defendant can do after an indictment is moved to dismiss that indictment. And I imagine we'll see motion practice here to that extent.

Starting point is 00:18:02 at like in consistent with Brian's statement about this, you know, his client is a software developer and all he did was developed software, we might see some motions that reflect that theme. And then once we get past motion practice, there will be discovery. The government has to produce evidence that they plan to use at trial. So they will have to give that discovery evidence over to the defense. And then there are some reciprocal obligations for the defense to also produce discovery they plan to use a trial. And then at the very end, we would see pretrial motions about what evidence can come in and out. We might see some expert discovery. I would imagine in a case like this, there will be experts call to talk about what the technology actually does and doesn't do.

Starting point is 00:18:50 And then there would be a trial if there's no plea. And we've discussed a few different things that you seem to believe the government got wrong, you know, one around the money transmission, another around writing software. And I was curious, like, what do you think is, are the two Romans best defense? So I think that it's important to note again that these are conspiracy charges. So they do, the government does not need to prove that the underlying violation occurred. They only need to prove that two people or more agreed to engage in conduct that would result in a violation. So I think the best defense to a conspiracy is we didn't have an agreement to do anything illegal, right?

Starting point is 00:19:37 So if you are able to show that you either didn't know the aims, like the goals of the conspiracy, or you didn't agree with somebody else to do a crime, then that is your defense to a conspiracy charge. Okay. All right. Well, this has been super interesting. Thank you so much for coming on Unchained. Thank you. Don't forget.

Starting point is 00:19:58 Next up is the weekly news recap. Today presented by veteran crypto reporter and Columbia University Night Badget Fellow Michael Del Castillo. Stick around for this week in crypto after this short break. Join over 80 million people using crypto.com, one of the easiest places to buy, trade, and spend over 250 cryptocurrencies. Spend your crypto anywhere using the crypto.com visa card. Get up to 5% cash back instantly. Plus 100% rebates for your Netflix and Spotify subscriptions and zero annual fees. Download the crypto.com app now and get $25 with the code Laura.

Starting point is 00:20:35 Link in the description. Amazon presents Jamal versus the Shih Tzu. Descending from the gray wolf, shih Tzu's live by their own untamed primal code of not giving a single Shih Tzu. But Jamal shopped on Amazon and bought dog treats, chew toys, and 32-1. ounces of carpet cleaner. Hey, Jamal, you've been promoted to pack leader.

Starting point is 00:21:04 Save the everyday with deals from Amazon. Hello, and thanks for tuning into this week's Crypto News Recap. I'm Michael Del Castillo, a Knight Badget Fellow at Columbia University. Just after Laura finished recording the podcast, news broke that Trinino Cash co-founder Roman Storm had gotten out on bail. According to his lawyer Brian Klein, who added on a tweet, I remain very disappointed that the prosecutors charged him because he developed software. Their novel legal theory has dangerous implications for all software developers. In other legal issues this week, the former FTX CEO Sam Bankman-Fried legal saga continues

Starting point is 00:21:48 to unfold. On Wednesday, U.S. federal judge Louis Kaplan granted Bankman Freed's lawyers permission to visit their client at the Metropolitan Detention Center in Brooklyn, New York, in preparation for his trial starting on October 3rd, according to a Coin desk report. However, the FTX founder's request for daily meetings at his lawyer's office or to transfer to a lower security prison was denied. Elsewhere, prosecutors at the U.S. Department of Justice filed a proposed set of jury instructions for Bankman Freed's trial commencing in October, detailing the seven counts against him, including wire fraud and money laundering.

Starting point is 00:22:30 Bankman-Freet's legal team's strategy and the court's decisions this week set the stage for the highly anticipated legal battle in the crypto space. Judge Kaplan granted Bankman-Fried permission to meet with his counsel in a cell block attorney room, allowing access to an internet-enabled laptop where he can view documents previously loaded as part of his defense. His lawyers have expressed concerns over delays and the voluminous discovery, including a list written by former Alamator Research CEO Caroline Ellison, titled, quote, things Sam is freaking out about, end quote, including Alameda's trading hedges, and ironically for a man once widely described by reporters as the White Knight of Crypto,

Starting point is 00:23:15 negative press coverage. Bangman Fried's trial is scheduled to begin October 1, and he faces a maximum of over 100 years in prison, if convicted of all charges. In a court appearance Tuesday, Bankman Fried pleaded not guilty to all charges. His lawyers sent him a letter to Judge Kaplan, explaining how they planned to use the October trial to show that Bankman Fried was acting in good faith when he followed previous legal counsel to auto-delete some information and to make loans to FTX. Moreover, FTX is seeking to sell, stake, and hedge with left in no small part of $3 billion in crypto. holdings, using Mike Novagrats' Galaxy Empire to advise and assist in maximizing value from the sales, according to recent court filings. OG. Defi liquidity pro-call balancer faced what appears to be a critical vulnerability affecting the latest version of the software that defines the liquidity pools behind much of the global crypto trading activity. After the balancer team experienced

Starting point is 00:24:23 the undisclosed problem, it sent an urgent Twitter. warning urging users to withdraw funds from the affected pools, including on the Ethereum Mainnet, Polygon, Arbitrum, and others. In a tweet, the team claimed it secured most of the total value locked in the protocol, but some funds remained at risk. In spite of being partially decentralized, Balancer users last year voted to give a small group called the Balancer Emergency Sub-DOW, the vow to kill vulnerable pools, enabling a proportional exit from the affected pools. Although Balancer estimated that just $10 million was still at risk, data shows that over $200 million has been withdrawn, with TVL falling a whopping 25% to around $544 million. The team plans to

Starting point is 00:25:14 provide additional details through a post-mortem report at a later time, reflecting what appears to be a swift and coordinated response to a potentially significant weakness in the DFI space. U.S. District Judge Jesse Furman sentenced a former product manager of NFT Marketplace OpenC, Nate Chastain, to three months in prison for insider trading in non-fungible tokens, marking the first ever digital asset insider trading conviction. Chastain was found guilty of exploiting confidential information about upcoming NFTs on OpenC's homepage, making profits of over $50,000. U.S. attorney Damien Williams said in a statement that the sentence should serve, as a, quote, warning to other corporate insiders that insider training in any marketplace will not be

Starting point is 00:26:04 tolerated, end quote. In addition to the prison term, Chastain was sentenced to home confinement, supervised release, and a $50,000 fine. Binance, one of the leading crypto exchanges, has faced a turbulent week marked by regulatory scrutiny, market fluctuations, and strategic partnerships. Binance's native token, BNB, stumbled to a one-year low, reaching $204 on Tuesday, and reflecting a 14% drop over the past week alone. This decline comes amid mounting scrutiny over Binance's operations, which increased this week following a Wall Street Journal report about the exchange letting Russian users circumvent sanctions and move money. Additionally, a $30 million hack against Venus, a decentralized marketplace, highlighted the potential risks associated with the liquidation of a large portion of BNB, which could cause cascading liquidations and damage the broader market.

Starting point is 00:27:02 Or, to put it another way, poorly written code could result in lost investor funds. In a strategic move, Binance's U.S. subsidiary, Binance.us, partnered with crypto payments for MoonPay to introduce a new U.S. dollar on-ramp. This partnership allows users to exchange dollars for the Tethercoin, aka USDT, which will be the new, quote, base asset, end quote, for transactions. Users can buy USDT using debit or credit cards and payment services like Apple Pay and Google Pay. However, some have expressed frustration over the high fees incurred while using MoonPay. Speaking of regulatory challenges for exchanges, Luxembourg-based cryptocurrency exchange BitStamp will end its ether staking services for U.S. users starting September 25,

Starting point is 00:27:55 according to a statement provided by BitStamp U.S.'s CEO to news site The Block. The decision follows recent actions from the SEC that targeted similar staking services seen as investment contracts. Coinbase acquired an equity stake in Circle. marking a significant partnership development amid challenges for USD coin or USDC, as it is perhaps better known. The joint announcement also detailed the expansion of USDC to six new blockchains, increasing the total number of chains supporting USDC to 15. This move comes after a turbulent period for the stable coin,

Starting point is 00:28:35 with its market cap falling from $55 billion in July 2022 to less than half, that, or about $25 billion at press time. The two companies will continue to generate revenue from USDC reserves interest income, sharing it based on the amount of USDA held on each platform. In a potentially important shift in strategy, Circle will assume full control over USDC issuance and governance. In 2018, Coinbase Incircle co-launched the Center Consortium to jointly manage USDC and planned to onboard additional members as the asset expanded its reach. That project is no more. In spite of shuttering the Center Consortium and the shift of power, Circle CEO Jeremy Aller

Starting point is 00:29:24 emphasized his commitment to making USDC the most widely used digital dollar in the world in a tweet. The U.S. Federal Bureau of Investigation issued an alert regarding the activities alleged of North Korean hackers warning cryptocurrency companies of a potential cash-out attempt involving stolen Bitcoin worth over $40 million. The alert focuses on hackers belonging to Trader Trader Group, that's T-R-A-D-E-R-T-O-R group, believed by the FBI to be associated with the Democratic People's Republic of Korea. The group is also believed to be the latest incarnation of a team of hackers' identified separately as both the Lazarus Group and APT-38, known for spearfishing methods where counterfeit emails are used to trick readers into clicking on links that introduce software

Starting point is 00:30:20 that steals money and data, locks out authorized users in exchange for a ransom, or any number of illicit actions. The FBI's investigation is tracked approximately 1,580 bitcoins stolen by the group from several significant heists, including thefts from payment processor Alpha Poe and others. The agency has urged private sector entities to closely examine blockchain data associated with Bitcoin addresses, its agents suspect of being involved, and called for increased vigilance against transactions involving these addresses. In a related note, the FBI and Thursday announced it has seized nearly $1.7 million in cryptocurrency between March and June. July of this year, with the majority of its seizures coming from a single exchange, finance.

Starting point is 00:31:11 On a more lighthearted note, Bitcoin, as you all probably know, has not been performing so well. For a more upbeat interpretation of the down market, your market update from stand-up comedian Ginny Hogan is just below. The coin's price plunged dramatically last week, which is wild. I had no idea it had been up to begin with. But it's true. Bitcoin dropped from 29 to 25, which is... to say it started getting Botox. At one point, Bitcoin shed 7% of its value in just 20 minutes,

Starting point is 00:31:40 which feels like it could be the advertising for a new Pilates program. And the price plunge led to mass liquidations, which is not nearly as sexy a phenomenon as the term suggests. But it's a bummer. Like, imagine you were planning to use your Bitcoin to buy a large plot of land in Siberia to evade taxes. Now you can only buy a medium large plot of land in Siberia to evade taxes. And it was Crypto's biggest one-day fall since the collapse of FTX. which was actually less than a year ago. Can you believe that in just nine months, SBF produced about 72,000 Excel spreadsheets proving his innocence?

Starting point is 00:32:13 So productive. The only thing I can do in nine months is like make a baby. McKinsey should totally hire him. I hear they have good Wi-Fi in his jail. Thanks so much for joining us today. Unchained is produced by me, Laura Shin, both up from Kevin Fuchs, Matt Pilcher, Zach Seward, Juan Aranovich, Sam Shre Rum,

Starting point is 00:32:30 Ginny Hogan, Leandro Camino, Pamma Jimdar, Shashon, and Marka Curry. Thanks for listening.

Unchained - Is This the End of DeFi? Why the US Government Is Going After Tornado Cash - Ep. 536

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