Today, a Dutch judge in the court of ‘s-Hertogenbosch ruled that Alexey Pertsev, one of the founders and a core developer of Tornado Cash, is guilty of money laundering. The court sentenced Pertsev to 64 months in prison. Over the past year, Tornado Cash has been at the center of DeFi regulation debates, garnering significant attention from the industry. Despite the team’s continuous emphasis on compliance, the DeFi giant Uniswap was still sued by the SEC this year. What does the guilty verdict of the Tornado Cash co-founder mean for future DeFi startups? How can DeFi coexist with regulation in the future?

Separation of Teams and Protocols: DeFi Regulation Still Unavoidable?

The trial of Tornado Cash serves as a stark warning for other cryptocurrency service providers. In April 2023, the U.S. Treasury released an assessment report on illegal financial activities in DeFi, highlighting the potential risks within DeFi services and analyzing how criminals exploit these services for illegal activities. Three months later, four U.S. senators introduced the “Crypto-Asset National Security Enhancement and Enforcement Act,” aiming to strengthen regulations on KYC, AML, and the DeFi sector.

The “Crypto-Asset National Security Enhancement and Enforcement Act” offers a new regulatory framework for DeFi. It mandates that DeFi should be regulated similarly to other cryptocurrency institutions, requiring any “person” capable of controlling the project to be held accountable. The act suggests that if no specific individual can control the DeFi service, then any investor with more than $250,000 invested in the project should be held responsible.

Related Reading:”What does the US court’s “friendly judgment” against Uniswap mean for DeFi regulation?》

In line with current regulatory concerns, the focus of the Pertsev trial centers on whether laws aimed at curbing money laundering can adapt to blockchain-based financial innovations and values such as anonymous transactions. During a hearing Pertsev attended in March, prosecutors argued that the protocol developers had not done enough to prevent criminals from using Tornado Cash. Pertsev’s defense countered that the prosecutors should consider the open-source and automated nature of Tornado Cash’s core smart contracts. “Holding Pertsev accountable for the actions of Tornado Cash users is misguided because these users are designed to be anonymous and independent.”

Keith Cheng, Pertsev’s defense attorney, stated that project contributors cannot prevent users from utilizing open-source smart contract code in any way they see fit. The protocol’s contributors form a decentralized organization without a single responsible party like a traditional company.

However, prosecutors rejected this view, asserting that the technological benefits do not outweigh the legal obligation to prevent the platform from aiding criminals and sanctioned entities (such as the North Korean hacker group Lazarus Group) in concealing the sources of stolen assets. Prosecutor Martine Boerlage stated, “Tornado Cash is more than just smart contracts; it operates like a company.”

Due to the contentious nature of the case, Pertsev’s trial in the Netherlands has been somewhat opaque, with the prosecution only disclosing his indictment a week before his trial. Preliminary hearings and a series of sessions were also conducted in Dutch.

Despite this, Pertsev has garnered significant support, including petitions, fundraising for legal fees, and statements of innocence from protocols that had been hacked. The crypto community, especially developers, has strongly protested Pertsev’s arrest, fearing that the charges against him could set a dangerous precedent for criminalizing software developers.

Previously, supporters of Alexey Pertsev distributed posters outside the Dutch court.

Earlier, U.S. regulatory bodies, including the Department of Justice (DOJ), filed criminal charges against Tornado Cash founders Roman Storm and Roman Semenov. The charges accuse them of conspiracy to launder money, violating sanctions, and operating an unlicensed money transmission business during Tornado Cash’s operation. Both face at least 20 years in prison. Storm was arrested last year and is set to be tried this September, while Semenov remains at large. The outcome of Pertsev’s trial is likely to influence the future trials of these two Tornado Cash founders.

Focus on Uniswap After Tornado Cash

Following Tornado Cash, several other crypto protocol owners have faced charges related to criminal activities on their platforms. For instance, Uniswap was accused of allowing fraudulent tokens to be issued and traded on its protocol, a lawsuit ultimately dismissed by the court in 2023.

Late last year, a16z wrote a comment letter for the Financial Stability Board’s (FSB) theme event on “International Regulation of Crypto-Asset Activities.” The letter emphasized distinguishing between DeFi and CeFi and suggested that an appropriate regulatory framework should regulate Web3 applications rather than Web3 protocols (regulating enterprises, not software). The debate over which aspects of DeFi protocols and applications suit the regulatory environment continues, but most legal experts agree that any DeFi front-end with broad U.S. ties must comply with U.S. sanctions laws.

On April 11, the U.S. Securities and Exchange Commission (SEC) issued a warning to Uniswap Labs, indicating potential enforcement action. This warning, known as a Wells Notice, provides the company with a final chance to refute any allegations before the SEC initiates a formal lawsuit. The specific nature of the SEC’s charges against Uniswap Labs remains unclear.

The market reacted sensitively to this news, with UNI prices plummeting from $14 to $9.58, a drop of over 14% within 24 hours. During this period, on-chain trading volume of UNI tokens surged, even topping Dexscreener’s hot list for Ethereum tokens.

Uniswap responded promptly. Founder Hayden Adams confirmed receiving the SEC warning on social media and issued an open letter in response. In the letter, Adams expressed confidence in the legality of their products and criticized the SEC for failing to create clear, informed regulations, instead choosing to target reputable crypto entities like Uniswap and Coinbase while allowing bad actors like FTX to “slip away.”

Adams emphasized Uniswap’s compliance-focused development path as a U.S.-based internet company and mentioned that the fight with the SEC could last for years, indicating readiness to appeal to the Supreme Court if necessary.

Related Reading:”“If someone needs to push for encryption compliance, we are the best person” - Uniswap founder’s open letter》

Tornado Cash: Still the Largest Crypto Mixer After Sanctions

Tornado Cash is a privacy protection protocol that can mix 10 types of cryptocurrencies, with the largest mixed asset being native ETH on the Ethereum mainnet. At its peak in July 2021, Tornado Cash’s pool contracts held over $700 million worth of ETH.

A week before Pertsev’s trial, an indictment shared by the court revealed that between July 9, 2019, and August 10, 2022, Pertsev, along with one or more individuals, allegedly engaged in habitual money laundering in countries including the Netherlands, Russia, the United States, and Dubai. The court believes Pertsev should have at least suspected the criminal origins of illegal transactions on the Tornado Cash platform.

The indictment listed nearly 40 transactions processed by Tornado Cash from various crypto platforms, totaling 535,809 ETH. This includes transactions from KuCoin and Liquid (an exchange acquired by FTX before its collapse in 2022). The largest transaction involved 175,100 ETH (approximately $585 million) from Axie Infinity’s Ronin Network, related to one of the largest thefts in cryptocurrency history. The attackers were the notorious North Korean hacker group Lazarus.

In August 2022, Tornado Cash and related Ethereum addresses were added to the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) Specially Designated Nationals (SDN) list. The U.S. Treasury claimed Tornado Cash was a key tool for the Lazarus Group, which was responsible for the $625 million Axie Infinity hack and other major cryptocurrency thefts.

By early May 2022, analysis indicated that the Lazarus Group had transferred 37,000 ETH, approximately $100 million, to Tornado Cash. Experts noted that “black money from state-sponsored hackers” accounted for 20% of the balance held in Tornado Cash’s smart contracts.

Despite sanctions and the legal battles involving its developers, Tornado Cash remains a prominent crypto mixer. The legal scrutiny surrounding Tornado Cash highlights the challenges of regulating privacy-focused blockchain technologies while balancing the prevention of illicit activities. The outcomes of these trials could set significant precedents for the future of decentralized finance and the legal responsibilities of developers in the blockchain space.

Related Reading:”Interpretation of the Toughest Crypto Sanctions in History: What Happened to Tornado Cash》

Tornado Cash has stated that despite numerous efforts, it cannot prevent the Lazarus Group from adding illicit funds to the platform. Tornado Cash is designed to help users obfuscate their on-chain transaction history, making it inherently challenging to stop such activities.

The crypto community views the developers’ prosecution as politically motivated, considering them political prisoners for merely writing code. They argue that the sanctions are not just an attack on cryptocurrencies but on the broader principles of privacy and open-source development.

Despite these sanctions, the impact on the Tornado Cash project itself has been minimal. In the month following the sanctions, $77.35 million in assets were still transferred through Tornado Cash on the Ethereum mainnet. This indicates that the protocol continues to be widely used, highlighting the complex interplay between regulatory actions and the decentralized nature of blockchain technology.

Related Reading:”Demand remains huge, Tornado Cash remains the largest crypto mixer on Ethereum after being sanctioned》

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