Tornado Cash Sanctions Expose Potential DeFi Achilles’ Heel

The U.S. Treasury has submitted a scrambled blockchain protocol to identify potential exposure to Tornado Cash, a licensed cryptocurrency mixer.

Authorities officially approved Ethereum-powered Tornado Cash on Monday and added its blockchain address to the Office of Foreign Assets Control (OFAC) blacklist.

Running on immutable smart contracts, Tornado Cash blends cryptocurrencies from many individuals to hide the origin of the funds. This is a privacy tool with many legitimate and beneficial uses, such as making personal donations to political causes or preventing casual financial surveillance.

Legitimate users can use cryptographic notes (like receipts) to prove the origin of funds from Tornado Cash when required by legal authorities.

However, officials claim it is a popular method of laundering stolen cryptocurrencies among North Korean hackers involved in many token bridge hacks, including those of Axie Infinity and Nomad. increase.

Circle of Stablecoin Issuers Begins Shortly After Latest US Treasury Sanctions on Tornado Cash Come to Light blacklist 45 Ethereum addresses designated by OFAC.

OFAC’s list includes addresses directly related to Tornado Cash, including various pools for mixing cryptocurrencies.Also Quote Tornado Cash addresses used by crypto grant program Gitcoin for field donations — the largest of them all came From the hackers behind the $37.5 million Iron Bank exploit last February.

Adding to the OFAC list will prevent the address owner from sending or receiving USDC. The move is not unprecedented. Virtually all centralized stablecoin issuers, including Circle and Tether, have censored bad actors in the past.

Needless to say, Infura, a major Ethereum infrastructure provider, removed Tornado Cash as a client overnight. “Our understanding is that they [Tornado Cash] We used Infura to support Ethereum calls made in our front-end user interface,” Bill Hughes, Director of Global Regulatory Affairs at ConsenSys, told Blockworks in an email.

However, some see Circle’s series of blacklist additions as an act of censorship at the request of a US government agency. This is a big no-no among parts of the cryptocurrency ecosystem.

MakerDAO stability mechanism depends on USDC

MakerDAO manages DAI, arguably the most decentralized stablecoin offering in the ecosystem. It is the 4th largest stablecoin with a circulation of his $7 billion.

DAI is novel in that MakerDAO stakeholders decide almost everything about the token. Asset backing, issuance and interest rates, staffing, investment allocation, support budgets, etc.

This is in contrast to how Tether and Circle, the two largest stablecoin issuers, operate. Both are privately held, centralized companies that make important decisions behind closed doors. Virtually no on-chain accountability, requiring basic supply statistics and simple proof to back them up. Over $120 billion in USDC and USDT is in circulation in the crypto industry.

With this in mind, MakerDAO potentially faces survival issues. The protocol is marketed as an “unbiased” and “decentralized” stablecoin that can be used by anyone, anywhere, relying on USDC to maintain its peg to the US dollar. USDC now accounts for about half of MakerDAO’s total collateral backing his DAI, up from about 30% a year ago.

MakerDAO sought USDC for price stability during a year of market turmoil, a period marked by stablecoins equivalent to the USDT bank run.

But the protocol’s exposure to USDC goes beyond centralized treasury. In an interview with Blockworks, MakerDAO head and cryptocurrency researcher Mika Honkasalo elaborated on something called the Price Stability Module (PSM).

As the name suggests, PSM helps lock the price of DAI to the US dollar, especially when demand outstrips supply. DAI will only be issued when over-collateralized deposits are made against the protocol. If many want his DAI tokens but have little collateral, a shortage of supply could cause the price of DAI to surge above the intended $1.

PSM was MakerDAO’s solution. Allows USDC holders to exchange their tokens for “expensive” DAI at dollar rates. This should provide an immediate lucrative arbitrage opportunity when the DAI price surges above $1, allowing the DAI price to rival USDC.

Anyone can submit USDC to MakerDAO’s PSM, at which point the token will be technically managed by MakerDAO.

This raised alarm bells for Honka Salo.

A completely new attack vector with few downsides

Bad actors could see the Treasury Department’s Tornado Cash web, which has already caught bystander donors via Gitcoin, as a blueprint for an entirely new attack vector. Namely, the guilt of sending USDC to sanctioned Tornado Cash, polluting it with it, and then transferring it to MakerDAO. – per associationdust attack.”

If that particular USDC goes on the sanctions list, the value of that USDC is theoretically zero and MakerDAO will lose a lot of collateral,” Honkasaro said.

Hypothetically, for example, an attacker who believes the FBI to be highly hostile to the cryptocurrency ecosystem would simultaneously start shorting DAI, causing the US Treasury Department to turn MakerDAO’s stability peg into Tornado Cash. may wait to authorize for “interactions” with That would undermine its support and, crucially, its price.

Holders of Maker’s MKR tokens are ultimately responsible for the stability of DAI. In this unlikely scenario, the protocol would create and sell her MKR as a last resort, destroying its market cap as well.

“Of course, there is no guarantee that you will be placed on the sanctions list,” Honcasaro said. “But depending on the process of how it’s selected, it’s possible, so it’s probably EV-positive. [expected value positive] Bed. “

Honkasaro has laid down protocols for diversifying into tangible, real-world assets such as Treasuries and bonds away from USDC, but those processes take time.

There is a point. According to Honkasalo, MakerDAO is not the only protocol susceptible to this kind of attack. This is potentially problematic for all DeFi protocols that have USDC assets as collateral.

Frax, the protocol behind the semi-algorithmic stablecoin of the same name, is similarly dependent on USDC inflows. OFAC sanctions.

“Actually all lending markets suffer from this problem equally. People just realized that DAI has problems, but the auto lending market is as much fueled by USDC as DAI,” Honkasalo said. said Mr.

“The real problem is even worse, because it spans all the different protocols that have USDC.”

However, Jerry Brito, executive director of Coincenter, a blockchain research group, has thrown cold water on the idea of ​​the US Treasury Department freely sanctioning any address that interacts with Tornado Cash.

“I think it’s unlikely. I’d be surprised if this shifts rapidly in those directions,” Brito told Blockworks. “From their previous statements, it seems they are very specifically concerned about mixers, especially mixers used by certain bad actors, such as North Korean hackers and ransomware attackers.”

Frax founder Sam Kazemian said in a Telegram chat on Monday about the risks posed by the USDC: Zero USDC overnight. ”

In fact, an apocalyptic scenario in which the Circle takes its loyalty to the United States to the extreme and blacklists anyone who interacts with Tornado Cash seems surreal.

However, Infura and Circle’s immediate compliance with OFAC sanctions exposes centralization vulnerabilities across DeFi, many of which may be currently unnoticed.

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