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What the OFAC Coin Center Lawsuit Means for Crypto Regulation

Nov. 3, 2022, 8:00 AM

It’s been a turbulent crypto winter. The market capitalization of digital assets has tumbled by an estimated $1.1 trillion compared to this time last year, while a continuous string of bankruptcies, price drops, and job losses have dealt a serious blow to crypto’s trust and integrity.

In response, crypto regulation has sped up across regions, moving from speculation to application. In September, the EU finalized Markets in Crypto Assets legislation, while the Financial Stability Oversight Council urged Congress to accelerate regulation of the crypto market.

Meanwhile, an important lawsuit is unfolding. In response to the Office of Foreign Assets Control’s decision to impose sanctions against crypto mixer Tornado Cash—claiming North Korean hackers used it to launder hundreds of millions of dollars—the non-profit Coin Center filed a lawsuit against OFAC.

Coin Center argues OFAC’s actions are unlawful, saying it lacks power to sanction decentralized software, and that Americans have the right to use privacy tools like Tornado Cash.

The lawsuit has shifted the crypto regulatory debate from government legislation and industry collaboration to potential litigation. What does this mean for crypto regulation moving forward and how should the industry respond?

Lawsuit Impact

The Treasury Department’s sanctions against Tornado Cash and Coin Center’s lawsuit represent a broader regulatory debate across the industry. Some in the crypto community ardently oppose centralized interference in the market, arguing it will stifle innovation and contradict crypto’s decentralized premise.

The Coin Center lawsuit strongly echoes this school of thought. Tornado Cash is “not a person” for the purposes of the OFAC statute, but also, Coin Center argues, “it is a privacy tool beyond the control of anyone.”

This suggests that decentralized software process should be free from regulation or government action. If true, then does decentralization mean that—by definition and design—a product does not fall under the rule of law?

This line of inquiry has serious legal implications. If this is indeed Coin Center’s implication, then it has taken an incredibly bold stance about how decentralized instruments should be applied. By this reasoning, any platform that facilitates payments through decentralized technology avoids responsibility as a licensed payment provider, precisely because its technology is decentralized.

This means, for example, that a decentralized system acting as a clearinghouse would be immune from liability if customer funds were stolen or frozen.

Regulation and Innovation

The argument that Coin Center seemingly presents, however, overlooks that crypto service providers ultimately cannot reside outside of regulation forever. When technology takes over the functions that would otherwise fall to people or entities, its creators and users can no longer claim it sits outside the rule of law.

Policymakers will not sit by and allow this framework to go unregulated even if Coin Center temporarily prevails in its lawsuit. And this is why regulatory measures are being drafted across jurisdictions and are expected to be implemented in the near future.

The crypto community should not view the coming of regulation as a dark cloud hanging over the industry. Regulatory measures—when tailored to the unique attributes of the crypto market—can offer clear guidelines on how decentralized technology should be applied, who may use it, and for what purpose.

Regulation can operate as a funnel for innovation, through which companies can reap the efficiency benefits of a software.

Moreover, if the crypto industry wants to play a role in today’s financial system, then it must adapt to the rules of this infrastructure. Many financial institutions recognize the potential of blockchain and distributed ledger technology, but hesitate to integrate this software into their business models due to lack of legal or regulatory certainty.

The introduction of clear rules could go a long way in helping crypto gain the trust and confidence it needs for firms to offer digital assets as part of their services and integrate DLT into their operational systems.

It is yet to be seen how the Coin Center lawsuit will pan out. However, regulation and innovation are not mutually exclusive. The crypto community should not reject regulation, but instead see it as a bridge towards greater application by financial institutions and markets. DLT cannot be beyond the control of anyone—and that’s a good thing.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Author Information

Charley Cooper is managing director at enterprise blockchain firm R3. Previously he was chief operating officer at the Commodity Futures Trading Commission and began his law career at Kirkland & Ellis.