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The Tornado Cash question: Fight or comply?

Protocol Fintech

Good morning, and welcome to Protocol Fintech. This Wednesday: the spin on Tornado Cash, BlockFi blame games and California’s crypto plan.

Off the chain

If PayPal’s origin story does get turned into a Hollywood show, there’s a burning question: Who will play the main characters? Podcast host Antonio García Martínez gamely tried to get David Sacks, Peter Thiel and Max Levchin to volunteer actor picks on his “Pull Request” show, but they all passed. Maybe Kevin McHale of “Glee” for Levchin? Definitely not Wallace Langham again for Thiel — I thought he was miscast on “The Social Network.” Matthew Broderick as Sacks? I welcome your suggestions, and can’t wait to stream this.

— Owen Thomas (email | twitter)

How to spin Tornado Cash

The Tornado Cash crackdown triggered a heated debate in crypto: Should the industry comply with the controversial Treasury Department order — or just ignore it? The department’s Office of Foreign Assets Control had sanctioned the crypto protocol, saying it was used for illicit activity. Crypto advocates including Ethereum co-founder Vitalik Buterin have defended it as an important tool for protecting users’ privacy. The government’s move sparked outrage in crypto. Some companies have taken a defiant stance. Others warn that that could be a mistake.

The feds are taking a harder line on crypto. The Treasury Department said it had to take action against a crypto protocol that’s been used to launder more than $7 billion worth of virtual currency, including $455 million stolen by a North Korean-sponsored hacking organization.

  • What makes the Tornado Cash crackdown significant is that it’s aimed not at the usual targets of law enforcement like crypto wallets linked to individuals or centralized exchanges run by identifiable companies but at open-source software. Tornado Cash is a mixer that helps give crypto holders privacy for legitimate transactions but that has also proven useful in criminal activity.
  • Circle CEO Jeremy Allaire said the U.S. government has “entered uncharted territory,” which he described as “a major turning point” in crypto. The government, he said, was “effectively imposing a ban on the use of an open-source software protocol address that commingled assets from likely licit and illicit actors.”
  • But Circle will comply, Allaire said: “We expect that nearly every responsible digital asset service provider in the world has also followed suit and blocked access to Tornado Cash addresses.” Coinbase also said it will “prevent its retail and institutional users from sending to or receiving from sanctioned addresses" including those associated with Tornado Cash, despite chief legal officer Paul Grewal’s tweeted misgivings about the privacy implications.
  • Tether, issuer of the biggest stablecoin, opted for a different approach, declaring in a blog post that “unilaterally freezing secondary market addresses could be a highly disruptive and reckless move.” But the crypto company suggested it will comply with law enforcement requests to freeze specific addresses.

Crypto is scrambling for a unified response. The battle over Tornado Cash shows crypto’s dilemma over the right balance between transparency and privacy in a time of heightened regulatory scrutiny.

  • Graham Friedman, senior director of strategy at Republic Crypto, said the Tornado Cash decision “might be an unprecedented sanctioning of code, something that generally would fall under First Amendment protections.” He expects the sanctions order to be challenged in court, he told Protocol.
  • He said lawyers for some DeFi companies “have gone very conservative” and “recommended that they actually reject any of the people that touch Tornado Cash.” But other crypto companies are pushing back, arguing that “capitulating” to the government sets a bad precedent, he added.
  • Crypto is trying to “have it both ways,” Klaros Group partner Jonah Crane argued. The industry has consistently touted how “blockchains are transparent and transactions are traceable, therefore crypto is not a good haven for criminals.” But now “a large contingent within the industry” is arguing that “obfuscation of transactions must be permitted, even if it means North Korea can launder stolen crypto proceeds,” citing the right to “free speech,” he told Protocol.
  • Pushing back against “overbearing regulation” is a good idea, but “whining about OFAC compliance issues may not be a great battle to pick,” said Greg Kidd, founder of VC firm Hard Yaka. Any system that downplays the importance of identity is “going to end up mixing green money with dark money — which is the whole foundation of the money-laundering industry.”

Taking a “catch me if you can” attitude isn’t smart, said Mike Fasanello, chief compliance officer of LVL. While he is critical of the Treasury Department’s move, which he said has a “distinct element of overreach,” brazen defiance is likely to backfire. “This is not an area [where] digital asset businesses want to test OFAC’s resolve — they will lose,” he told Protocol.

— Benjamin Pimentel (email | twitter)

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On the money

On Protocol: California is close to approving a new regulatory regime for crypto businesses. The state legislature passed a bill this week that would require a license to offer crypto financial services; it now awaits the governor’s signature.

Consumer confidence is bouncing back. U.S. consumer confidence increased by more than the forecast in August to reach the highest point since May, suggesting Americans are feeling less gloomy as gas prices fall.

House lawmakers want answers on crypto fraud. The House Committee on Oversight and Reform sent letters to digital asset exchanges Coinbase, FTX, Binance.US, Kraken and KuCoin seeking information and documents about how they are protecting consumers against scams. Federal financial regulators also received the inquiry.

Bitcoin dipped below $20,000. The cryptocurrency is under pressure from the Federal Reserve's plan to continue raising interest rates and waning investor appetite for risk.

Walmart asks court to nix the FTC's money-transfer lawsuit. Walmart said the FTC's lawsuit — which alleges that the retail giant turned a "blind eye" to fraud on its wire services — is an overreach by the regulator. is weighing options to remain a private company. The embattled online mortgage firm has held discussions to remain a private company through alternative financing arrangements, according to an SEC filing, which could terminate a planned merger with a SPAC to go public.

New York City officials want American Express and Mastercard to more clearly track gun sales. The city's pension funds filed a shareholder proposal to require the credit card companies to create merchant codes for standalone gun and ammunition stores, which they say would make it easier to spot unusually large purchases.


Edwin Aoki, PayPal’s crypto CTO, is optimistic about the regulatory mood in Washington. “There has been a subtle shift over the last six months in the U.S. towards a pro-innovation stance, that says this industry and these tools and technologies exist, there are opportunities and positives that could come out of this, and now let’s make sure we have the right structures to ensure the risks and negatives are minimized,” he told the Australian Financial Review.

Seven Seven Six is the latest VC firm to raise a crypto fund and Kryptós is eyeing opportunities in the market crash, partner Katelin Holloway told the Information: “It’s on sale. Everything is on sale.”

Ripple’s Stuart Alderoty thinks the SEC, not Three Arrows Capital, deserves blame for BlockFi’s fire sale and bankruptcies in the crypto sector. “The SEC’s shakedown of BlockFi led to a mess. BlockFi ended up on the auction block and two other companies with similar businesses went belly up,” he wrote in a letter to the Wall Street Journal.

Just one question for …

Stanley Huang, co-founder and chief technology officer at Moxo.

Huang worked as an engineer at Webex and Cisco before co-founding Moxo, a digital workflow software company that serves the financial services, consulting, legal and other industries.

What do you worry about in fintech?

There are two candidates that come to mind, with the first being mobile payments and contactless technology. This new and booming trend is beginning to gain traction but has yet to reach its full potential in Western markets. Disparate solutions exist but there has yet to be a unified solution that brings the multitude of payment capabilities under one roof. Emerging markets such as China have moved ahead with this trend and are building out the capabilities to be more end-user friendly.

AI has also made huge strides in the digital payments landscape, especially from a customer point of view. Technology such as chatbots, natural language processing and big data have been instrumental in elevating customer experiences as well as smoothing over any points of friction. But although effective, the technology is still too premature to replace human touch in high-touch verticals with a lot of customer interaction. Striking the right balance of automation and personalization is still a challenge for fintech, and needs to be applied strategically in the right use cases, otherwise, it can reduce the end-user experience rather than improve it.

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Thanks for reading — see you tomorrow!

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