Tornado Cash Smart Contracts Cleared of OFAC Sanctions in Landmark Ruling

In a significant legal development, a U.S. appeals court ruled that the Treasury Department exceeded its authority by sanctioning the immutable smart contracts of Tornado Cash. The ruling, issued on November 26, marks a victory for the crypto community and raises important questions about the scope of government authority over decentralized technologies.

The Fifth Circuit Court of Appeals overturned a previous decision by the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC), which had placed Tornado Cash’s smart contracts on its Specially Designated Nationals (SDN) list. The court determined that these smart contracts, operating autonomously without human intervention, could not be classified as “property” under U.S. law.

Ruling: Immutable Smart Contracts Cannot Be Regulated as Property

The court’s decision centers around the notion that immutable smart contracts are fundamentally different from traditional entities that can be owned or controlled. Tornado Cash's smart contracts, which operate autonomously and cannot be altered after creation, were found to fall outside the scope of the International Emergency Economic Powers Act (IEEPA), a federal law that grants the President the power to regulate international economic transactions and impose sanctions.

In its ruling, the appeals court emphasized that the smart contracts are lines of code, not physical property or services, and therefore do not qualify for sanctions under the IEEPA. The court clarified that because the smart contracts cannot be updated or controlled by any central entity, they cannot be “blocked” or treated as property subject to government regulation.

The ‘Trusted Setup Ceremony’ and Decentralization

The decision referenced Tornado Cash's "trusted setup ceremony" held in May 2020, in which over 1,000 participants contributed cryptographic data to finalize the parameters of the smart contracts. This process ensured that the contracts were immutable and not subject to future updates or administrative control.

Following the setup, governance of the protocol was handed over to the Tornado Cash community, which uses the TORN token—a decentralized governance token launched in 2021—to vote on protocol changes. This shift to community control further reinforces the decentralized and autonomous nature of Tornado Cash, differentiating it from services or entities that could be classified under IEEPA.

Support for Open-Source Technology

The ruling has been welcomed by proponents of open-source technology and decentralized finance (DeFi), including Coinbase's Chief Legal Officer, Paul Grewal. Grewal emphasized that "Blocking open-source technology entirely because some users misuse it is not what Congress authorized," highlighting the importance of protecting the principles of open-source development in the crypto industry.

Coinbase, which financially supported the legal challenge against the Treasury Department’s sanctions, has long advocated for the protection of open-source projects in the blockchain space. The decision is seen as a win for the broader crypto community, which has expressed concerns about the increasing regulatory pressure on decentralized technologies.

Tornado Cash’s Legal Battle and Implications

The case stems from the U.S. Treasury’s decision in August 2022 to sanction Tornado Cash, accusing the protocol of facilitating over $7 billion in illicit transactions, including money laundering and ransomware payments. In response, six individuals, including two Coinbase employees, filed a lawsuit challenging the inclusion of 44 Tornado Cash smart contract addresses on the SDN list, arguing that the Treasury had overstepped its legal authority.

A Texas district court had initially upheld the sanctions, arguing that Tornado Cash could be treated as an "entity" under OFAC regulations. However, the Fifth Circuit’s recent ruling rejects this interpretation, asserting that Tornado Cash’s decentralized and autonomous nature makes it distinct from other entities that could be sanctioned.

Looking Ahead: The Future of Tornado Cash and Crypto Regulations

While the ruling specifically clears the Tornado Cash smart contracts from the sanctions list, legal experts caution that other aspects of Tornado Cash or related protocols may still face regulatory scrutiny. ConsenSys lawyer Bill Hughes noted that while this is a "good win," the Supreme Court is unlikely to reverse the decision, though other parts of Tornado Cash's ecosystem could still face sanctions.

The decision also serves as a reminder of the complex legal landscape surrounding decentralized technologies and the ongoing debate over how regulators should approach the rapidly evolving crypto space. With the court ruling that smart contracts cannot be treated as property or services, the case sets a significant precedent for future legal challenges involving decentralized protocols and blockchain technologies.