What Tornado Cash Tells Us About Crypto KYC
The aptly named platform, Tornado Cash, is a decentralized protocol designed to spin cryptocurrency funds between multiple blockchains and service nodes* to scramble any traceability of funds.
The blockchain is a 100% transparent infrastructure designed to trace funds from A to B to C and so on. This app, however, allowed individuals to bypass that inherent transparency, creating an environment for bad actors to bounce funds around on-chain. The end product was ‘clean’ crypto that could be withdrawn via a new wallet.
This concept was contentious for numerous reasons, most of all due to the lack of a Know Your Customer (KYC) process. The platform became notorious amongst organized crime groups, who reportedly laundered around $2 billion since its inception.
It becomes clear that 2.2 billion US dollars, proceeding from criminal Ether, have been laundered.
Developer of Tornado Cash gets jail sentence for laundering billions of dollars in cryptocurrency
The US Department of Treasury sanctioned Tornado Cash in August 2022 and charged two of the founders a year later. The chargers were under conspiracy to commit and provide a platform for money laundering. Alexey Pertsev, a Russian national, is the latest to be arrested in Amsterdam and has been sentenced to 64 months.
One CoinDesk reporter stated that it was ‘painfully obvious’ what the real intentions behind the development of Tornado Cash were — to conceal identity and enable money laundering. The same report continued that while they did not take custody of the funds at any point, there was no attempt to collect and verify customer information from users. This is something all financial institutions must adhere to.
This case gives us a great deal of information about the industry’s regulations.
- Cryptocurrency applications are increasingly seen as platforms with enormous implications for the broader financial system.
- These platforms are now also being perceived as, and licensed as, traditional financial institutions.
- Crypto platforms must, therefore, embark on similar processes to obtain, verify, and vet customer information — this is the KYC process.
This is already happening around the world for centralized cryptocurrency platforms, known as Virtual Asset Service Providers (VASPs). Local and international regulatory bodies are collectively demanding enhanced regulatory compliance from crypto exchanges, primarily due to their connection with money laundering and illicit activity.
This makes it highly likely that decentralized applications (dApps) will also be subject to heightened regulation. Regulating decentralized applications has proved very challenging, and Tornado Cash is the ultimate proof. This case study, amongst others, brings increasing scrutiny to decentralized platforms.
Why is KYC Important for Crypto Services?
KYC is a standardized term for the processes a business uses to identify clients and monitor them. Its purpose is to ensure that the customer does not pose a threat or risk to the company. In the financial system, it includes the verification of user identities and a set of comprehensive Anti-Money Laundering (AML) checks. For more information on this, read our blog on KYC crypto processes below.
The omission of any KYC verification for a protocol like Tornado Cash made the project look highly suspicious. But this begs the question of how the founders got away with it initially.
This was a decentralized protocol, meaning that once the smart contract had been created, it did the heavy lifting. The founders never took custody of the funds and, to all intents and purposes, were not ‘involved’ in the dirty laundry. This ‘legal grey area’, however, could never last. As the previously mentioned CoinDesk reporter stated, the platform’s real ambitions were obvious.
KYC and AML solutions are becoming increasingly significant for VASPs as they provide a one-stop shop for compliance with national and international regulations. In the wake of the rise in illegal use cases, KYC services, such as ComplyCube, provide a simple yet comprehensive remedy.
*A node is one of the focal points of a blockchain and one of the many computers that run the decentralized blockchain system. Nodes are fundamental for validating transactions and ensuring network security.
