ETH merge and Tornado Cash in SDN list | Weekly Insights

Aug 12, 2022

ETH Merge

It's Finally Happening

After countless delays, it now appears as though "the Merge" on Ethereum is finally happening around September 15/16, 2022, after the Goerli testnet was successfully merged yesterday. The Merge is the first step in a 5-step roadmap for the Etheruem blockchain, which aims to make Ethereum future-proof by improving scalability. In the first step, the current Ethereum mainnet (execution layer) and the Proof-of-Stake (PoS) Beacon Chain will be merged together. This will remove all Proof-of-Work (PoW) mining from the network, reducing power usage by 99.9%, reducing Ethereum issuance through removing mining rewards and improving speeds from 13 Transfers per Second (TPS) to 100,000 TPS. The reduced issuance will heavily reduce inflation, with some people even suggesting the Merge will make ETH a deflationary asset.

Not Everybody is Happy

While Ethereum network users are excited about this transition, miners are not: all the mining hardware previously purchased and optimized for mining Ethereum will become obsolete. This has prompted miners to advocate for forking the Ethereum network and continuing the blockchain as an Ethereum Proof-of-Work network. BitMEX even launched a futures contract to allow users to speculate on the ETH merge.

ETC Cooperative Urges Not to Fork

However, many people believe the ETH PoW chain will implode when the first block is mined. The ETC cooperative, who manage the Ethereum Classic fork, published an open letter in which they explain why they believe ETHPoW is doomed to fail.

ETC was forked from Ethereum many years prior to the current dApp infrastructure, which made forking Ethereum quite an easy task with minimal additional work. However, today thousands of dApps run autonomously on the Ethereum network with even more people working off-chain to maintain the current infrastructure.

ETH PoW Can Fork a Chain, but not a Community

Even if ETH PoW manages to produce client software that can be run by the miner community, dApp owners may not support the new chain and deactivate their smart contracts to avoid confusing users and enabling scammers. Even if they decide to continue running their dApps, other dApps that they rely on may cease operations, which introduces attack vectors for hackers to empty our smart contract balances.

The Aftermath and Dwindling Support

If that isn't enough, any staked Ether would also become essentially worthless, as the PoW chain does not support PoS, and DAOs would be split into Ethereum and Ethereum PoW DAOs, leading to challenges in governance. Finally, a further critical attack vector is that of Oracle attacks: Chainlink, Ethereum's largest Oracle, announced they would not support the ETH PoW fork. This means any smart contract that relies on Oracles could see their funds drained. USDC provider Circle and USDT provider Tether announced they would not support ETH PoW, which means that the moment the fork is launched their pegs would break, wreaking further havoc on what appears to be a dwindling narrative.

In a surprise move, Tron's co-founder and Poloniex-backer Justin Sun announced his stablecoin USDD will support the new Ethereum PoW fork. Ethereum founder Vitalik Buterin says, however, that he believes that proponents of the fork are "Couple of outsiders that basically have exchanges, and mostly just want to make a quick buck".

While the industry at large is primarily advocating support for the Proof-of-Stake chain, only time will tell whether the Ethereum Proof-of-Work fork will be successful.

Tornado Cash added to US sanctions list

What is Tornado Cash?

Tornado Cash is a crypto currency mixer that operates on the Ethereum blockchain and indiscriminately facilitates anonymous transactions by obfuscating their origin, destination, and counter-parties, with no attempt to determine their origin. Tornado receives a variety of transactions and mixes them together before transmitting them to their individual recipients. While the purported purpose is to increase privacy, mixers like Tornado are commonly used by illicit actors to launder funds, especially those stolen during significant heists.

What is Office of Foreign Assets Control (OFAC)?

OFAC administers and enforces sanctions against high profile individuals including major international terrorists, drug trafficking kingpins, and the financial/political elite of certain countries deemed hostile to American interests.

On August 8, 2022 Tornado Cash and all the Ethereum wallet addresses associated with Tornado Cash and its smart contracts were added to OFAC’s Specially Designated Nationals And Blocked Persons List (SDN List). In short, it is illegal for any US citizen or company to engage in trade, economic transactions with any person, company, or country on the SDN list.

What is SDN list?

The Specially Designated Nationals and Blocked Persons List is a United States government sanctions/embargo measure targeting U.S.-designated terrorists, officials and beneficiaries of certain authoritarian regimes, and international criminals (e.g. drug traffickers).

What are the implications?

It seems possible that breach of OFAC sanctions would occur if a miner or validator produces (or validates) an Ethereum block which contains a transaction including one of the Ethereum addresses on the SDN list.

Either technical countermeasures (voluntary censorship) or moving business outside US jurisdiction is expected.
CEX will be expected to use their Chainanalysis software to block and report all customer transactions which are in breach of sanctions.
Non-US divisions of exchanges are separate legal entities, but could be seen as de facto ‘foreign branches’ of the US entity. Exchanges are strongly incentivized to ensure that their foreign-registered group companies also comply fully with OFAC sanctions.
All assets in Tornado as of August 8th are tainted. Tether, Circle, and BitGo will refuse to redeem these tokens.

What next?

It will be interesting to see how the law is enforced. Protocols solving for transactional privacy face a challenging path forward and protocols following compliance and working with law enforcement but also protecting user transactional privacy might emerge.