With crypto mixers, specifically Tornado Cash, increasingly under regulatory scrutiny, facing sanctions, and generally attracting the wrong kind of attention, it seems like an appropriate time to objectively look at these services. Namely, what exactly doe crypto mixers do, why would individuals or institutions seek to use these services, and what are the potential legal and regulatory implications of doing so? As with most everything else in the cryptoasset space, investors and users of these products and services should conduct due diligence on the service itself, who else utilizes said service, and examples of how previous issues have been resolved.
In other words, this is a prime example of what it is important to always conduct robust due diligence.
For the purposes of this conversation the focus will be on noncustodial crypto mixers, which can make it more difficult for regulators to take action against bad actors, but also reduce the risk for users of these services. Due to the fact that the cryptoassets are never held by a trusted third party or other entity, and instead are handled entirely by smart contracts and the underlying blockchain the risk of theft by unethical actors is reduced.
Let’s take a look at some of key questions and considerations that investors and regulators alike should keep in mind when discussing, assessing, or potentially using crypto mixers.
What is a crypto mixer? Much like how the name describes, a crypto mixer is a service (which can be centralized or decentralized) that increases the anonymity of certain crypto transactions. Users deposit crypto into a smart contract designed to execute the mixing transaction from one address. After a predetermined period of time, the users can withdraw the previously deposited tokens from a different address. The specifics of the mixing process are unique to every crypto mixer, and users are able to verify/confirm the crypto that was deposited via a number of cryptographic techniques that – again – vary from protocol to protocol.
Why would investors use such a service? It is also worth remembering that the origin of blockchain and cryptoassets – no matter how far it has developed since – was heavily influenced by libertarian ideas. These include, but are not limited to, a desire for increased privacy and anonymity regarding personal transactions, and a much reduced role for governments, regulators, and (specific to crypto) incumbent financial institutions. Crypto mixers do increase the anonymity of and privacy of crypto transactions, which can come in handy for individuals seeking privacy, or users seeking to circumvent restrictions that might exist in some jurisdictions such as nations that have – effectively – banned crypto transactions altogether.
What are the risks? As has been demonstrated recently, the view that governments and regulators have of crypto mixers is mixed at best (no pun intended). Allegations of mixers being used to facilitate money laundering and criminal activities of all kinds have been levied against the entire sector. Sanctions have been implemented against several of the highest profile providers in the space, with the Office of Foreign Asset Control (OFAC) designating a smart contract as a Specially Designated National, a label usually reserved for nation-states. As crypto mixers continue to become higher profile, this will in turn lead to more regulators taking long looks at the operations of these protocols as well as the investors leveraging them.
From an advisory perspective there are certainly use cases and situations within which a crypto mixer can be used for perfectly legitimate purposes. It is also worth pointing out that traditional financial services firms are routinely found to have facilitated illegal payments, or laundered money obtained from illicit sources. That said, it seems safe to say that going forward there will be many more questions that uses, investors, and institutions associated with crypto mixers will need to answer. Clients of all sizes should keep that in mind prior to allocating assets to mixers, or entering into business with counterparties who do so.
Like everything in the blockchain and cryptoasset space, crypto mixers have rapidly developed, grown, and have burst into the mainstream financial conversation at a blistering pace. As regulators continue to play catch up to the private sector, regulation and enforcement will invariably become more commonplace. Crypto investors, developers, and the advisors to these entrepreneurs will be well served to take note.