Some people think crypto transactions are anonymous. They insist that crypto is a great way to launder money. It isn’t. In practice, crypto transactions are not anonymous; they are pseudonymous. In general, crypto transactions are a terrible way to launder money because the sender and receiver of every transaction are publicly viewable on a blockchain. However, there are some cryptocurrencies, some digital wallets, and some decentralized applications (dApps) specifically designed for crypto laundering. And they are very, very good. Let’s explore.
On March 29, 2022, about 30 minutes before Axie Infinity co-founder Jeff “The Jiho” Zirlin and I took the stage to do a fireside keynote at NFT|LA, we learned that his company had been the victim of the largest hack in crypto history: 173,600 ETH (roughly $600 million at the time of the hack) and 25.5 million USDC ($25.5 million).
At that time, most of the ETH was sitting in a wallet that was being watched by everyone in the crypto world. The Jiho assured the audience that law enforcement was on the case and that the hackers would be found. Why? Because everyone could see the ETH and the USDC sitting in the hacker’s wallet.
Around April 4, 2022, the hackers started moving the stolen ETH to a smart contract called Tornado.cash. This is where the story gets interesting.
Mixers (aka “Tumblers”)
Tornado Cash is a mixer (aka “tumbler”) service. It hides wallet identification by breaking the on-chain link between the recipient and destination addresses. The smart contract that accepts cryptocurrency deposits allows crypto (ETH, in this case) to be withdrawn by different addresses. Whenever ETH is withdrawn by a new address, there is no way to link the withdrawal to the deposit, ensuring complete privacy.
For geeks: Tornado Cash enables private transactions on the Ethereum blockchain by breaking the link between the sender and receiver’s addresses. This non-custodial solution is based on zkSNARKs (Zero-Knowledge Succinct Non-Interactive Argument of Knowledge), which is a cryptographic proof that allows one party to prove it possesses certain information without revealing that information. The proof is made possible using a secret key created before the transaction takes place. It is used as part of the protocol for the privacy coin, Zcash.
To use Tornado Cash the user generates a secret and sends its hash (called a commitment) along with the deposit amount to the Tornado smart contract. The contract accepts the deposit and adds the commitment to its list of deposits.
When the user decides to make a withdrawal, the user provides a proof that they possess a secret to an unspent commitment from the smart contract’s list of deposits. (zkSNARK technology allows that to happen without revealing which exact deposit corresponds to this secret.) The smart contract will check the proof and transfer deposited funds to the address specified for withdrawal. Importantly, a third-party auditor will not be able to link the deposits to the withdrawals or vice versa.
There have been centralized mixers for as long as there have been crypto transactions. But they are dangerous. One has to trust the centralized authority to play by the rules and not abscond with your crypto.
Nowadays, there are “smart pools,” where users combine their currency with non-privacy seekers such as investors or the pool’s treasury, and “stealth pools,” which do a better job at separating user-submitted crypto from reserve and investor crypto.
Bitcoin (BTC) users wishing to make their transactions private can choose a transaction type called a “CoinJoin.” The transaction protocol is incorporated into both the Wasabi and Samourai crypto wallet apps. CoinJoins are complicated by the need to properly time the transactions with other users. An application called JoinMarket solves for this by allowing users to pre-pay for a CoinJoin. Of course, the art of obfuscation is ever-evolving. CoinSwap is a good example of a work in progress.
When privacy is really important, professional privacy-seekers use purpose-built privacy coins such as Zcash (ZEC) and Monero (XMR). The foundational principles of both of these organizations focus on the relentless pursuit of privacy. When you think of money laundering, sex trafficking, drug lords, and selling arms to the enemy, these are the cryptocurrencies of choice.
But—and it’s a big but—most of us are used to transacting in private and the vast majority of our transactions are perfectly legal and legit. There is a need for privacy in the doing of our digital lives, and cryptocurrencies such as Zcash and Monero are likely to become critical components of our Web3 privacy and digital self-sovereignty.
What About Green Dollar Bills?
What is more launderable, a duffle bag of $100 bills or a million dollars’ worth of ETH? The technical answer is that it is far easier to launder a duffle bag of $100 bills than it is to launder a million dollars’ worth of ETH. US dollars are accepted everywhere on earth for absolutely every good and service. ETH? Not so much. But if you are committed to avoiding imperial entanglement and you are sanguine with the idea of committing a criminal act, the tools you need are (as they have always been) open source.
It’s Early Days
There are a fair number of domestic and international agencies focused on reducing money laundering. The danger is that these same regulators will dramatically curtail the freedom that DeFi and Web3 promise. Of course, it is early days and the technology is far beyond our current policies and regulations. Policy-makers, regulators, and lawmakers will never catch up, so this is a competition sure to be won by those who have a deep understanding of the technology and how to use it.
We’re about to launch Metacademy.xyz. It’s a Web3 training site that is free of charge and risk-free. It’s a good place to start your crypto, NFT, Web3, metaverse education. I also have a best-selling book on the subject. That said, these subjects are covered in thousands of places. There are great videos on YouTube, fantastic blog posts, amazing free (and paid) courses, and no end to the number of books. The information you need is plentiful and mostly free. Education is the best way to prepare yourself for the coming revolution in monetary policy and the advent of Web3.
Author’s note: This is not a sponsored post. I am the author of this article and it expresses my own opinions. I am not, nor is my company, receiving compensation for it. I am not a financial advisor. Nothing contained herein should be considered financial advice. If you are considering any type of investment you should conduct your own research and, if necessary, seek the advice of a licensed financial advisor.