On Sept. 8, Coinbase announced it was bankrolling a lawsuit against the United States Treasury Department. The cryptocurrency exchange is funding a lawsuit brought by six people that challenges the sanctions on Tornado Cash. And on Sept. 9, Securities and Exchange Commission (SEC) Chair Gary Gensler announced he was working hard with Congress to create legislation to increase cryptocurrency regulations.

But these two stories are not mutually exclusive. The sequence of events proves that governments are purely reactive rather than proactive when it comes to decentralized finance (DeFi).

Tornado Cash was sanctioned by the Office of Foreign Assets Control (OFAC) back in August. OFAC claimed the smart contract mixer has helped to launder more than $7 billion worth of cryptocurrency since its creation in 2019, including over $455 million stolen by the North Korean-linked hackers Lazarus Group.

Coinbase CEO Brian Armstrong said in a statement that Treasury went too far, taking “the unprecedented step of sanctioning an entire technology instead of specific individuals.” In addition to claiming the sanctions exceeded the department’s authority, Coinbase argued the measures:

Remove privacy and security for crypto users;

Harm innocent people; and

Stifle innovation.

The next day, Gensler doubled down on his push for tougher regulation of the DeFi market, claiming crypto companies wouldn’t prosper without it. “Nothing about the crypto markets is incompatible with the securities laws. Investor protection is just as relevant, regardless of underlying technologies.”

Not only does his choice of words such as “regardless of underlying technologies” betray his lack of understanding of crypto and blockchain technology, but his speech prompted an outcry from the Web3 community, with many claiming government regulation is a wolf in sheep’s clothing.

Jake Chervinksy, a lawyer and head of policy at the Blockchain Association, tweeted in response, “Crypto is a novel & unique technology: how it should be regulated is a major question for Congress (not the SEC Chair) to decide.”

Security legislation is worrying enough. But the Tornado Cash sanctions set an alarming benchmark for anyone involved in digital assets. Not only are blockchain technology and cryptography constantly changing — what’s secure now might not be secure in the near future and almost certainly won’t be secure next year — but there are a myriad of legitimate applications for the likes of blockchain tech.

DeFi is all about privacy. The clue’s in the name — decentralized finance. Mixers such as Tornado Cash further protect the privacy of its users by mixing users’ deposits and withdrawals in liquidity pools, hiding their addresses and safeguarding their identities. Users want to protect the privacy of their transactions for a range of lawful reasons.

In this case, one of the plaintiffs used the mixer to donate funds to Ukraine anonymously. Another was an early adopter of crypto and now has a significant social media following, with his public ENS name connected to his Twitter account. He used the smart contract to protect his security while transacting. Now their assets are trapped in Tornado Cash.

A person’s finances include some of their most sensitive personal information. And law-abiding citizens have the right to keep this private. But it’s this very privacy that will be eroded by the sort of regulation recently proposed by Gensler, the SEC and other governments around the world.

As is the case with these sanctions, arresting people for using services for lawful and even benevolent acts, not to mention locking up developers for writing open-source code that wasn’t illegal at the time of creation, feels like Orwellian-levels of dystopian.

Treasury officials have since backtracked, clarifying in guidance that, in fact, “interacting with open-source code itself, in a way that does not involve a prohibited transaction with Tornado Cash, is not prohibited.” The guidance adds that copying the protocol’s code, publishing the code and visiting the website, are all allowed.

Although not officially related, the timing and similarities between the two stories are telling. Gensler likened regulation to traffic control, saying — “Detroit would not have taken off without some traffic lights and cops on the beat.” Armstrong used a highways and heist analogy, saying, “Sanctioning open-source software is like permanently shutting down a highway because robbers used it to flee a crime scene.” And he’s not wrong.

How many talented developers will now be dissuaded from writing game-changing code that could not only innovate industries, but help people across the world? A small number of bad actors should not hinder the progress of a technology with such huge potential to revolutionize sectors beyond even finance.

The Coinbase lawsuit is a pivotal case in the history of cryptocurrency, and the result — whatever it is — will have huge ramifications for DeFi. And of course, its users.

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