On November 26, the U.S. Court of Appeals for the Fifth Circuit vacated the sanctions imposed by OFAC on the Tornado Cash cryptocurrency mixer. The opinion is well reasoned—compared with the district court, it shows a deeper and clearer understanding of the project’s structure and how the protocol operates.
Moreover, the court addressed a number of important yet contentious legal questions. As a matter of law, this precedent will carry enormous weight.
For ForkLog, Sergey Ostrovsky, a lawyer and partner at Aurum, unpacks the appellate ruling, its key holdings and the possible implications for the blockchain industry.
Immutable smart contracts are not property
At the heart of the Tornado Cash case was whether immutable smart contracts can be treated as property or as services. The answer determines whether sanctions under the IEEPA can apply.
In legal theory, property is something that can be owned, controlled and disposed of, including by restricting third-party access. The court held that immutable smart contracts do not meet these criteria because there is no single person who can alter them or prevent others from using them. Even if they wished to, the protocol’s creators cannot.
The same goes for services: a smart contract may be used to provide them, but it is not, in itself, a service. The court cited a legal dictionary defining a “service” as “an intangible product in the form of human effort, such as labor, skill, or advice.” An immutable smart contract, by contrast, does not entail human effort.
On that basis, the court held that “the immutable Tornado Cash smart contracts (strings of code that provide privacy) are not ‘property’.”
A smart contract is not a legal contract
Smart contracts and legal contracts are different things. I argued as much in a recent article for ForkLog; now that view has official validation.
The court gave two reasons:
- A legal contract is an agreement between two or more parties. With immutable contracts, there is no counterparty, so there is no one with whom to conclude an agreement.
- A legal contract requires offer, acceptance and consideration. Even if a user makes an offer, there is no person on the protocol’s side who could accept it.
The court also contrasted immutable and mutable smart contracts. Although the latter may facilitate a contract between their operator and a third party, the smart contract itself is a tool and is not the legal agreement.
The appellate court also took issue with the vending-machine analogy offered by the district court. The analogy ran: when a buyer interacts with a machine, he makes a deal with the person who installed and stocked it, which resembles using smart contracts in transactions with virtual assets.
The appeals court noted that even if Tornado Cash once looked like a vending machine, it no longer does, because the contracts have become immutable and no one controls the protocol.
The upshot: code is not law. To give code or a smart contract legal force and effect, it must be combined with appropriate legal instruments.
Crypto mixers are not inherently criminal
Notably, the court acknowledged that cryptocurrency mixers and other privacy-enhancing solutions, including Tornado Cash, are widely used for lawful purposes such as protecting data confidentiality and personal safety. Sanctioning an entire sector of the crypto industry because of a few bad actors risks infringing the rights of law-abiding citizens and stifling innovation.
Conclusions
The ruling is an important victory for the industry and a significant moment for financial privacy. In essence, technologies that provide anonymity cannot be sanctioned merely because a limited number of people use them unlawfully.
Regulators must demonstrate a link between a specific violation and the tool employed, rather than treating privacy-preserving technologies as a monolithic threat.