FT Cryptofinance: DeFi is DeFi until Washington says it’s not

Hello and welcome to the FT’s Cryptofinance newsletter. Come for crypto’s ongoing battle with the US government, and stay for Matt Hancock’s hilarious debut in the metaverse. Have thoughts on what you’d like to read in this newsletter? Email me at scott.chipolina@ft.com.

Crypto evangelists will tell you decentralised finance (DeFi) is a window into a utopian future that replaces the prying eyes of government and regulators with privacy and financial freedom.

It turns out that worldview collapses once the US government — or more specifically, the Office of Foreign Assets Control — says so. After Ofac added Tornado Cash — a crypto mixing service accused of acting as a conduit for billions of dollars worth of laundered crypto — to its sanctions list, DeFi platforms have been rushing to comply with Uncle Sam.

“We’ve seen a tremendous amount of interest in our sanctions screening and compliance solutions in the wake of sanctions,” Esteban Castaño, co-founder and chief executive of prominent blockchain analytics company TRM Labs, told me this week.

TRM Labs has witnessed a five-times increase in inbound interest via its website from DeFi projects between July and August — aligning with Ofac’s sanctions against Blender and Tornado Cash, two “mixers” that can be used to obscure the trail of crypto funds. Both platforms, the US Treasury claims, were used by North Korean hackers.

Chainalysis, another well-established blockchain analytics firm, has seen a roughly 570 per cent increase in page views about the company’s oracle — a computer program called a smart contract that screens crypto wallet addresses for sanctions risk — since the Tornado Cash designation.

“Neither full transparency nor total anonymity is ideal — in DeFi or crypto more broadly. Ultimately regulators need the appropriate levels of oversight,” Andrew Fierman, head of sanctions strategy at Chainalysis, told me.

It’s not just decentralised finance that’s taking notice, either. Changpeng Zhao, chief executive of crypto exchange Binance, spoke to my Financial Times colleagues in March, just days after Russia’s full-scale invasion of Ukraine sparked widespread concern about crypto being used to evade western sanctions.

“The Ofac sanctions are not a joke . . . if you don’t do this well, you end up in jail,” Zhao said at the time.

While crypto sanctions evasion has been in the limelight for months, there has been a renewed sense of urgency on behalf of the DeFi community to comply. Earlier this month, Tron founder and general crypto big name Justin Sun was temporarily blocked from popular DeFi platform Aave after someone sent him “0.1 ETH randomly from Tornado Cash”.

“Maybe a lot of crypto businesses assumed, ‘well, it’s unlikely that I’m going to have any exposure regardless’ . . . but when Tornado Cash, which is a service that is popular within the DeFi community, gets sanctioned, a lot of folks are more seriously considering if and how they may have exposure to that service,” Castaño said.

On a call discussing all things Tornado Cash, Paige Berges, anti-corruption and international risk group counsel for law firm Ropes and Gray told me Ofac’s behaviour was nothing new.

“This is the way the US regulators have always operated, I think Ofac in particular, which is ‘well, tough, you want to use the US financial system? These are the conditions.’ And as long as they continue to have the leverage that they do, or the US financial system continues to have the leverage and the influence that it does, then that’s continued to work,” Berges said.

Yet, for those truly faithful to the DeFi utopia, all is not lost. Matthew Green, who teaches cryptography at Johns Hopkins University, archived a version of the Tornado Cash source code online. He said he had worked with this code as a researcher and used it to teach classes.

DeFi privacy defenders even have an ally — you might be surprised to hear — in Congress. US congressman Tom Emmer published a letter this week saying “technology is neutral, and the expectation of privacy is neutral”.

The week’s highlights:

• This week will go down in the history books as the week former UK Health Secretary Matt Hancock entered the metaverse. If you ask me, Hancock’s avatar looks much more like Jason Statham than it does the MP for West Suffolk, but in any case, you don’t want to miss my colleague Jemima Kelly’s great take on the hunky Tory.

• Coinbase has been hit with a host of problems this year, ranging from rescinded job offers to a tumbling stock price. Chief executive Brian Armstrong said on CNBC this week that he wanted the exchange to stop relying so highly on trading revenue in what would mark a significant strategy shift.

• The High Court of Singapore this week recognised the appointment of liquidators for collapsed crypto hedge fund Three Arrows Capital. In July this year, the liquidators claimed 3AC’s directors — Su Zhu and Kyle Davies — had not yet co-operated with them in “any meaningful manner”. This week, a person familiar with the matter told me the liquidators have now seen “the beginnings of co-operation” with 3AC’s directors in recent weeks.

Hong Fang, chief executive of crypto exchange OKCoin, criticised rivals that poured funds into sponsorship deals during last year’s crypto bull market, only to see their headcounts dwindle in the wake of this year’s market crash.

“Marketing spend, sponsorship spend. I’ve seen some companies putting a lot of money there. That works in a bull market, but it doesn’t necessarily work in a bear market.”

Data mining

One of the most interesting aspects of Ofac’s Tornado Cash designation is whether it’s even an effective policy to impose sanctions on smart contracts as opposed to corporate entities or specific individuals — the kinds of things that typically end up on sanctions lists.

Data compiled by CryptoCompare suggest the designation is already proving to be effective in limiting the number of transactions on the mixing service. Between August 8 — the date of the designation — and earlier this week, both withdrawals and deposits on Tornado Cash have been steadily declining.

I’ll paraphrase a tweet I recall doing the rounds deep in DeFi Twitter: “I think what I do is important . . . but not go to jail important.”

That’s it for this week. See you at the same time next Friday. Until then, have a great weekend!