Cryptocurrencies have been the subject of many debates over privacy, security, and regulation. Anonymity is one of the features of cryptocurrencies that have fueled their popularity and mass adoption. This means individuals can conduct private transactions on the blockchain without worrying about their details being exposed.
We’re all aware of the strategic advantages of staying anonymous on the internet in this day and age. Although unknown to most, especially newcomers to the space, the anonymity feature of cryptocurrencies has an exception: public blockchains.
While it may seem that cryptocurrencies offer privacy, this is an illusion created by public blockchains. In reality, cryptocurrency transactions are not as private or anonymous as you might think. This is because most cryptocurrencies operate on a public ledger, which means anyone can access it and see all transactions made with an address.
A blockchain is maintained by a network of computers (nodes) that validate new transactions and add them to the existing record. The blockchain is a distributed database that maintains a continuously growing list of data records. Each record, called a “block,” contains a timestamp and a link to the previous block.
Public blockchains are transparent, meaning anyone can see all the transactions made on a network—including their origin and destination. With a wallet address and a blockchain explorer, you can easily see the total number of tokens in the wallet as well as its inflows and outflows.
The problem with the information retrieval system on public blockchains is that it makes it easy for governments and hackers to track down users who want to remain anonymous. If an individual posts their wallet address in a public forum, it is easy to find out what that wallet holds. This undermines the concept of anonymity.
The increased demand for private and anonymous cryptocurrency transactions prompted the creation of privacy coins and advanced technologies such as crypto mixers. Privacy coins are cryptocurrencies that offer complete anonymity through specific private transaction features. Some of the most popular privacy coins include Monero (XMR), Zcash (ZEC), and Dash (DASH).
Crypto mixers allow individuals to send funds to wallets without worrying about the records of their transactions being available on the blockchain.
This article focuses on crypto mixers, exploring their underlying technology and their benefits and drawbacks. Tornado Cash, a popular crypto mixing service, is used as a case study in this piece. This is due to its recent headline-worthy activities and run-ins with US authorities.
What is a Crypto Mixer?
A crypto mixer, also known as a coin tumbler, is a service that allows people to conceal their transaction history by mixing different streams of cryptocurrencies. Those who use this service crave complete anonymity, which traditional cryptocurrency transactions do not provide.
A crypto mixer takes cryptocurrencies from different sources or wallet addresses, mixes them, and then sends them out to other addresses, thereby anonymizing transactions. When a crypto mix is completed, it is difficult to determine the destination of a coin sent to the service. Most crypto tumblers do not require users to go through any Know Your Customer (KYC) checks, making them popular.
There are different types of crypto mixing services. Centralized mixers are organizations that accept cryptocurrencies from users and then, manually or using automated software, mix them with the coins of others.
Typically, users must add the service fee to the coins they send, and the mixer places the coins in a pool before mixing them with others. They then send a new cryptocurrency to the address of the recipient. Blender.io is an example of a centralized coin mixer.
The second type is the decentralized mixer, which uses a permissionless peer-to-peer mechanism to conceal transactions. In this case, different users pool their coins, which are subsequently shared according to deposit proportions.
The difference between decentralized mixers and their counterparts is the absence of a centralized authority that completes the transaction.
Decentralized coin mixers typically utilize open-source protocols for their operations; an example is Tornado Cash. As a decentralized service, smart contracts enable users to deposit Ethereum-based tokens into the service and withdraw their funds from another wallet address. This makes the anonymization of transactions easier.
Crypto mixers, though innovative, have been extensively used for illegal activities, such as laundering funds stolen from DeFi protocols by hackers. The following are some examples of illicit transactions involving crypto mixers.
- Blender.io, a bitcoin mixer, was the first crypto mixer sanctioned by the OFAC. The service is reported to have been used by North Korean state-sponsored hackers, Lazarus Group, in a large-scale hack on Axie Infinity’s Ronin network in March 2022, resulting in approximately $620 million in losses. According to the OFAC, Blender.io was used to process $20.5 million of the stolen funds.
- Helix, a darknet bitcoin mixer, was the first bitcoin mixer penalized by FinCEN in October 2020 for violating anti-money laundering regulations. Larry Dean Harmon, the service’s founder, was fined $60 million after pleading guilty to one count of conspiracy to launder monetary instruments. Helix is reported to have processed 354,468 BTC between July 2014 and its closure in December 2017.
- The US Department of Justice dubbed Bitcoin Fog, a bitcoin mixer, the “longest-running bitcoin money-laundering service on the darknet.” Roman Sterlingov, a Russian-Swedish national, was apprehended in April 2021 and is accused of laundering up to $336 million in bitcoin since the service’s launch in 2011.
How does a Crypto Mixer Work?
A crypto mixer works by mixing coins from multiple sources and redistributing them to the recipient addresses. Since the coins are mixed, it is difficult to trace who the exact recipient of a coin is. Some are more advanced in their operation than others, but the underlying principle is consistent.
Suppose an individual has a particular amount of coins in a wallet and wishes to conceal the wallet’s transaction history and record. In that case, they can employ the services of a crypto mixer.
- They send the tokens to the mixing service whenever they want to conduct any transaction using that wallet. Usually, they are expected to also send the service fee, which is deducted from the total amount of tokens transferred.
- The mixing service places these tokens in a pool of cryptocurrencies deposited by other users.
- The mixer then sends fresh coins to the designated receiving addresses of the different users.
When tokens are sent to a mixer, anyone tracking their movement from one address to another may suffer a setback. This is because it is nearly impossible to determine the recipient of the funds sent from the sending address being tracked.
Is it legal to use crypto mixers?
The legality of a cryptocurrency mixer is determined by the user’s location. Some jurisdictions may consider this service illegal for different reasons, mainly because it makes it easier to conceal crypto transactions and launder digital assets.
In some regions, crypto mixing services are mandated to register with financial authorities. As part of their guidelines, they are also expected to request that their users undergo a Know Your Customer (KYC) process.
Before using a crypto mixing service, whether decentralized or centralized, ensure that it is legal in your jurisdiction.
Using a crypto mixer does not necessarily make you seem shady. Still, due to the associated risks, it is crucial to conduct due diligence before using one. For example, a crypto mixing service could be a target for hackers looking to steal the pool of cryptocurrencies deposited by users.
What is Tornado Cash?
Tornado Cash is a permissionless and decentralized coin mixing service that allows individuals to anonymize their transactions using a pool of coins. It is an open-source, non-custodial privacy solution based on the Ethereum blockchain and caters to Ether (ETH) and ERC20 tokens.
As a decentralized service, it uses smart contracts, allowing users to deposit their tokens into the pool and withdraw them to another address.
Once the funds have been withdrawn, it is nearly impossible to determine the origin of the tokens. The system functions through the usage of zero-knowledge proofs, allowing users to conceal their transaction history.
At the moment, the Tornado Cash ecosystem is controlled by the community. The TORN token is the native token of this ecosystem, and like many other native tokens, it is used in the governance process. Holders of the ERC-20 token can use them to vote or submit proposals.
Using Tornado Cash is a seamless process. The user has to first deposit their tokens on the protocol. Immediately they do this, they receive a randomly generated key, which should be stored securely.
Anytime users want to receive their tokens, they must prove they hold the valid key. It is prudent to withdraw the tokens using a newly generated address.
When the user deposits their tokens on Tornado Cash, the smart contracts add the funds to other deposits, breaking the link between the source and the receiving address.
Why are there several controversies surrounding Tornado Cash?
Tornado Cash’s anonymity service has been used by several criminals to launder illicit proceeds. As previously stated, some hackers have used this service to try to clean up their stolen coins and mask the money trail.
This has drawn the attention of various financial law enforcement authorities worldwide, particularly those based in the United States. The following are notable instances where Tornado Cash has been used for illicit activities in the last four years.
- In January 2018, Singapore-based cryptocurrency exchange Crypto.com was hacked, and on-chain data from PeckShield suggested that 4,600 ETH in stolen funds were laundered through Tornado Cash.
- In April 2022, hackers used a re-entrancy attack to breach Ola Finance and withdrew up to $3.6 million in cryptocurrencies using Tornado Cash.
- According to the U.S. Treasury Department, Tornado Cash was used to launder over $96 million in funds stolen during the June 2022 attack on Harmony’s Horizon bridge, as well as at least $7.8 million from a hack of Nomad, a cross-chain bridge.
- In June 2022, the hackers of Inverse Finance also used Tornado Cash to anonymize their transactions, resulting in the loss of approximately $1.2 million in cryptocurrencies.
Tornado Cash was added to the U.S. sanctions list by the Office of Foreign Asset Control (OFAC) on August 8, 2022.
The sanction was imposed because the U.S. agency believes the coin mixing service was used in various money-laundering schemes totaling more than $7 billion.
Two days later, Alexey Pertsev, a programmer for the crypto mixing service, was arrested by Dutch authorities, sparking heated debates across the crypto community.
Rep. Tom Hemmer, a member of the United States Congress, stated that “the United States Treasury Department’s sanctioning of the Tornado Cash cryptocurrency mixer was an unprecedented move threatening privacy and innovation.”
In Conclusion,
- A crypto mixer, also known as a coin tumbler, is a service that allows people to conceal their transaction history by mixing their tokens with different streams of cryptocurrencies.
- A crypto mixer works by mixing coins from multiple sources and redistributing them to the receiving addresses.
- Centralized mixers accept cryptocurrencies from users and then manually or automatically mix them with coins from other users.
- Decentralized mixers use a permissionless peer-to-peer model to conceal transactions.
- Tornado Cash is a permissionless and decentralized coin mixing service that allows users to anonymize their transactions by mixing coins from a pool.
Disclaimer: This article is intended solely for informational purposes and should not be considered trading or investment advice. Nothing herein should be construed as financial, legal, or tax advice. Trading or investing in cryptocurrencies carries a considerable risk of financial loss. Always conduct due diligence.
If you would like to read more articles like this, visit DeFi Planet and follow us on Twitter, LinkedIn, Facebook, and Instagram.
“Take control of your crypto portfolio with MARKETS PRO, DeFi Planet’s suite of analytics tools.”
