The Crypto Enthusiast and The Regulator: What OFAC is, Could Be, and Should Be Doing to Regulate CryptoCurrencies | Sheppard Mullin Richter & Hampton LLP

On May 6, the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) designated a cryptocurrency mixer,, as a Specially Designated National (SDN). That sanction follows a number of applications and sanctions that we have discussed earlier here and here.

The action is the latest in a fascinating back-and-forth between the crypto industry and its regulators, as both sides explore a new world of currency movements and what controls can and should be placed in it. To illustrate the parties ’positions, we offer the following discussion between an enthusiastic cryptographic blockchain lawyer (played by our partner, Gabriel Khoury) and a skeptical regulatory lawyer (played by our partner, Reid Whitten).

Keep in mind that we do not intend to resolve what will certainly be an ongoing debate, we simply set out the panorama of the discussion by elucidating some points of view of the various stakeholders. We are, (borrowing a terribly manipulative phrase), “starting the conversation.”

Enthusiasts: First, some background on Blender, which is a “mixer” of cryptocurrencies. Mixers hide the identity of your encryption and reduce the chances of third-party tracking software tracking your encryption. A cryptocurrency mixer is used primarily for legitimate reasons.

Skeptical: Whoah whoah whoah! Objection. That’s a pretty speculative characterization. Feel free and name legitimate reasons to a mixer could be used, but let’s calmly editorialize so soon.

Enthusiasts: Ok, just the facts. Many centralized cryptocurrency exchanges track all transactions, which can easily expose a user to illicit actors – people who can spy on or steal your data. Using a mixer, you can hide your hidden cryptographic transactions from those illicit actors. . .

Yes, and since I see you striving to point it out, they can also be used to hide transactions from intrusive governments.

Skeptical: Ejem.

Enthusiasts: Well, from governments, intrusive or not.

With Bitcoin, for example, if a user, we call him User A, sends a Bitcoin to User B, that transaction is logged and visible in that blockchain. Mixers are software applications that mix User A’s cryptographic payment with other users’ cryptocurrencies and send a mixture of cryptocurrencies to one or more User A-designated addresses. which improves the privacy and autonomy of users. Thus, the fact that user A sent a Bitcoin to user B is not easily discernible from that blockchain record.

Skeptical: True, so a user, user A, puts their Bitcoins or Dogecoins or whatever, the mixer throws them with Bitcoins and Dogecoins and Ethereum and Tether from other users, and then returns them to User A (or User). B) a equivalent value of the resulting mixture of coins. User A and user B are unaware of the origin of their new coin variety, only that it has the equivalent value of what was put (minus, presumably, some fee for the mixing service). Is that right?

Enthusiasts: Correct. Nowadays, blockchain analysis companies can easily track who owns that cryptocurrency. So, these cryptocurrency mixers are reviving the original libertarian cryptographic ideals of privacy, autonomy, and decentralization that were originally promised by the Bitcoin Whitepaper.

Skeptical: Ok, but the mixer is specifically designed to hide where the funds are coming from. That’s not far from a literal washing machine, as it can mix and wipe out illicit bottoms, mask them, and make them impossible to trace (ok, it’s still a figurative washing machine, but you get the idea).

One can imagine user A telling the authorities, “What, me? Keep the product of a crime? Why not! This is just the random variety of coins that came out of the mixer! They could not be identified with a crime.”

Enthusiasts: Maybe, but let’s think bigger than that. In fact, there are at least four reasons why a person would use a mixer to: (1) protect their encryption by hiding the source of transactions on an open network; (2) prevent hacking by hiding the movement of your cryptography; (3) safeguard their identity; and (4) avoid government regulation by keeping the volume of its transactions private.

Skeptical: Hmmm, the latter can also be called “tax evasion.”

Enthusiasts: Perhaps, and I will also admit that money laundering should probably be on that list as a fifth possible use of a mixer. However, OFAC makes it clear that most virtual currency activity is lawful and that most illicit uses are prevented by implementing appropriate anti-money laundering / anti-terrorist financing (AML / CFT) controls and sanctions. to prevent sanctioned people and other illicit actors from exploding. virtual currency to undermine U.S. foreign policy and national security interests. It is also worth noting that some private cryptographic mixers comply with the legal requirements of the Bank Secrecy Act.

Skeptical: Interesting, but I would note that just last year, a Bitcoin blending operator pleaded guilty to a $ 300 million money laundering conspiracy, a Russian-Swedish national was arrested for allegedly laundering $ 335 million in cryptocurrencies through a mixer and a hacker. he stole more than $ 33 million in a major cryptocurrency exchange, then allegedly laundered the currency through a cryptocurrency mixer. And these examples are just the ones the federal government has captured!

Enthusiasts: . . . and you might find that those examples might be considered incredible for the cryptographic industry. Think about it, market participants don’t want illicit actors to steal their hard-earned money, and mixers help prevent these illicit actors by hiding and protecting participants ’funds. The more illicit actors are caught using mixers, the more legitimate mixers can become because they are eliminating bad actors.

Skeptical: That’s an interesting view, but it looks like mixers would have a long way to go before I could see them beyond an impediment to law enforcement. I mean, the good part about the blockchain, from a regulator’s perspective, is that once they find the “wrong actor,” they can track transactions from the actor’s portfolio through the immutable record of the blockchain. If the bad actor withdraws money from North Korea in cryptocurrencies and the FBI can connect that actor to the wallet that took the money out of a sanctioned country, then there is a permanent and unalterable situation. public record where that money is going!

And I don’t want to pick cryptocurrency mixes. Mixers are not the only way criminals use crypto to prevent law enforcement. There are also privacy-focused tokens that offer (apparently) total separation between the address of the wallet and the identity of the holder.

Perhaps we can agree that there are many considerations here, many to regulate, but probably also some deference to the advantages of a successful mostly mostly anonymous means of conducting transactions.

Enthusiasts: I agree on all aspects. Criminals trying to evade law enforcement will happen whether or not cryptographic mixers exist. I would argue that cryptographic transactions are generally more secure than suspicious cash transactions because the blockchain allows for a literal public ledger. Delivering cash in a briefcase without witnesses makes it virtually impossible to track funds.[1] At least with blockchain technology, some kind of record is saved.


Participants in the cryptocurrency market should pay attention to the regulatory space in the coming weeks and months. Following President Biden’s cryptocurrency executive order, the application of state and federal cryptography has grown at a faster rate than ever before. This indicates that these agencies are preparing for a regulatory storm next year. Stay tuned for updates as we continue the conversation here.[2]


[1] Note, that is definitely not legal advice, nor really any kind of life advice. Do not deliver or accept suitcases full of money based on any statement in this article.

[2] * Sigh * Sorry, we promise to create more original terminology.

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