On November 26, 2024, the US Court of Appeals for the Fifth Circuit ruled that the US Department of the Treasury's Office of Foreign Assets Control (OFAC) exceeded its statutory authority when it designated the digital asset mixer Tornado Cash as a Specially Designated National (SDN) under Executive Order (EO) 13694 and EO 13722. The court's opinion in the case, Joseph Van Loon, et al. v. Department of the Treasury, is a rare loss for OFAC and significant victory for the digital asset industry. OFAC's sanctions against Tornado Cash were novel—it was the first time that OFAC targeted a decentralized protocol and its actions raised significant concern among the digital asset community, which viewed OFAC as targeting computer code and not specific persons. The case was brought by a group of Tornado Cash users backed by industry.
The Fifth Circuit's decision has significant implications for the digital asset industry, the reach of OFAC's regulatory powers, and the ability of litigants to challenge OFAC following the Supreme Court's prior decision overturning Chevron deference.
The think tank Coin Center brought a similar case in Florida and is appealing to the 11th Circuit after losing at the district court level.
OFAC Sanctions on Tornado Cash
In August 2022, OFAC designated Tornado Cash as a SDN pursuant to EO 13694. In November 2022, after significant criticism, OFAC withdrew its initial sanctions designation and concurrently re-designated Tornado Cash pursuant to EO 13694 and EO 13722. These Executive Orders were issued under the authority ofthe International Emergency Economic Powers Act (IEEPA) and the North Korea Sanctions and Policy Enhancement Act. OFAC alleged that Tornado Cash had been used to launder more than $7 billion worth of cryptocurrency since its inception, including over $455 million stolen by the Lazarus Group, a North Korean state-sponsored hacking group.
In re-designating Tornado Cash, OFAC determined that Tornado Cash was a "person" that was eligible for designation under the relevant authorities because it was an "entity" consisting of (1) the Tornado Cash founders and developers and (2) the Tornado Cash DAO. OFAC also identified the smart contracts underpinning the Tornado Cash protocol as property in which Tornado Cash has a "property interest," rendering them blocked property.
The Fifth Circuit Decision
The appellants argued three theories: (i) Tornado Cash is not a foreign "national" or "person," (ii) the immutable smart contracts are not "property," and (iii) Tornado Cash cannot have a property "interest" in the immutable smart contracts. The Fifth Circuit ruled only on the second argument, finding that immutable smart contracts are not property and did not reach a conclusion with respect to the other two arguments advanced by the appellants.
In the Fifth Circuit's view, the immutable smart contracts lacked the core characteristics of property, including the ability to be owned or controlled and the ability to exclude others from enjoyment of their benefit. The court concluded that no person, Tornado Cash or others, could own or exercise dominion over the immutable smart contracts. Further, no one could update, remove, or otherwise control those smart contracts in a way that would exclude anyone from using them. The court also highlighted that because the immutable smart contracts are unchangeable and unremovable, OFAC's designation does not actually prevent persons from using the protocol or withdrawing or accessing tokens held in the protocol.
The Firth Circuit relied principally upon a common sense understanding of the word "property," which is not a defined term in IEEPA. Interestingly, the court placed significantly less emphasis on OFAC's regulatory definition of "property" citing to the recent Supreme Court ruling overturning Chevron, which reduced the deference federal courts give to administrative agencies in interpreting the statutes.
However, the Fifth Circuit concluded that, even if it were to defer to OFAC's definition of property under IEEPA, which includes, in part, all "contracts" and "services," the immutable smart contracts would still be outside the scope of that definition. In contrast to the district court, the Fifth Circuit held that immutable smart contracts are not contracts. The court concluded that immutable smart contracts lacked the essential requirements of a contract because there is only one party (the third-party user) involved in a transaction with an immutable smart contract. There is no counterparty, just the immutable software code. Tornado Cash, including its founders, its developers, and its DAO, cannot "revoke" the immutable contracts even if they wished to do so because no one controls the immutable smart contracts or their operation.
The Fifth Circuit also concluded that the immutable smart contracts are not a "service" within the scope of OFAC's definition of property. The court explained that a "service" must entail human effort, and that smart contracts are more akin to a tool that is used in providing a service than a service itself. In addition, the court concluded that Tornado Cash does not own the services provided by the immutable smart contracts. The court found that nothing suggests that Tornado Cash itself receives fees from transactions through either mutable or immutable smart contracts (as opposed to adjacent software such as relayers) and that none of the immutable smart contracts entitle the creators to a benefit.
Implications and Uncertainty
Although the Fifth Circuit's decision invalidates OFAC's sanctions on Tornado Cash in the short term, considerable uncertainty remains given the limited holding of the decision, the breadth of the Fifth Circuit's order, ongoing related litigation, and the potential for future legislative action.
Limitations of the Fifth Circuit's Decision
As noted above, the Fifth Circuit did not take a position on two of the claims raised by the appellants: (i) whether Tornado Cash was an "entity" that could be designated under IEEPA, and (ii) whether Tornado Cash, if it were an entity subject to IEEPA, had an interest in the immutable smart contracts.
Additionally, the court said little about whether mutable smart contracts are property, but suggested that they may be. The court described mutable smart contracts as "capable of being owned in the sense that Tornado Cash developers can create new smart contracts and disconnect old mutable contracts[,]" which would make them inaccessible and unusable. The court suggested that mutable smart contracts may also be more akin to a contract because the mutable smart contract "owner" could revoke the offer to a third-party since the mutable smart contract is changeable. It is unclear precisely what constitutes an immutable versus mutable smart contract, which may be an area of considerable focus in the future, particularly if OFAC targets other supposedly mutable smart contracts.
Although the Fifth Circuit's reasoning concerns whether immutable smart contracts are property, the court's order appears to reach beyond the sanctionability of the immutable smart contracts. The Fifth Circuit's remand order appears to invalidate the Tornado Cash sanctions designation as a whole, rather than just prohibiting the sanctions from blocking the Ethereum addresses of the immutable smart contracts. Thus, the order would invalidate not only the blocking of immutable smart contracts but also OFAC's sanctions applicable to the Tornado Cash "entity" consisting of the founders and developers and the DAO and any mutable Tornado Cash smart contracts named in OFAC's sanctions designation of November 8, 2022.
The Fifth Circuit's analysis and remand order therefore creates some uncertainty as to the ability of OFAC to designate actors involved with similar future protocols, provided the designation does not include the underlying protocol. For example, it seems that the ruling would not necessarily prohibit OFAC designating a DAO maintaining a decentralized platform run by immutable smart contracts provided it did not seek to identify the underlying protocol as blocked property. It is also somewhat unclear why the order seemingly extends to mutable smart contracts involved in the Tornado Cash protocol, as the court's reasoning suggested that mutability was a fundamental distinction in its analysis.
Possibility of Appeal and Other Pending Actions
The White House and the Treasury Department have not yet issued a statement on the Fifth Circuit's decision. It is unclear whether the Biden administration will seek to appeal the decision to the US Supreme Court. The administration may be concerned that a Supreme Court decision would limit its discretion to interpret certain terms under IEEPA. Regardless of what the Biden administration seeks to do, it is also possible the incoming Trump administration would decline to appeal the ruling given its crypto-friendly posture during the campaign and the pro-crypto positions of several of its nominees, including the nominee for Treasury Secretary Scott Bessent.
Moreover, Coin Center's appeal in the Eleventh Circuit remains pending. The Eleventh Circuit panel held oral argument in that case last month. The Eleventh Circuit could depart from the Fifth Circuit's view on whether the immutable smart contracts are property under IEEPA and it could address some of the questions left open by the Fifth Circuit's decision. OFAC may be waiting for the outcome of the Eleventh Circuit case before it appeals to the Supreme Court. Typically, a split between the US Courts of Appeal increases the chances that the Supreme Court will weigh in.
A criminal money laundering case against the founders of Tornado is also continuing in New York and is unlikely to be materially impacted by this ruling.
Future Congressional Action
In its opinion, the Fifth Circuit remarked that "[w]e readily recognize the real-world downsides of certain uncontrollable technology falling outside of OFAC's sanctioning authority." The court expressed that amending IEEPA's "blind spots or smoothing its disruptive effects" is "Congress's job." It is unclear whether Congress will take up that invitation. OFAC's actions with respect to Tornado Cash received criticism from members of both parties and expanding OFAC's powers with respect to blockchain technology seems unlikely to be a top priority of the new Congress and incoming Trump administration.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
