On November 26, a unanimous panel of three judges from the Fifth Circuit Court ruled that the Treasury Department’s Office of Foreign Assets Control (OFAC) acted arbitrarily and without sufficient justification when it “exceeded the authority granted by Congress” by imposing sanctions on the open-source, self-executing software Tornado Cash, instead of targeting the “individuals and entities misusing it”.
In simpler terms, Congress did not authorize OFAC to sanction software code that does not belong to anyone.
“The Fifth Circuit’s decision is a victory for privacy, financial freedom, and the rule of law,” said Zach Smith, Senior Legal Fellow at the Heritage Foundation.
The Start of the Conflict
Tornado Cash is a cryptocurrency mixer that makes tracking cryptocurrency transactions more difficult. While the service has many legitimate and legal uses, it has also been misused for illicit purposes. For example, cybercriminals and hostile states have employed Tornado Cash and similar services to conceal their unlawful activities.
Due to these actions, OFAC added numerous Tornado Cash addresses to its Specially Designated Nationals and Blocked Persons (SDN) list. However, under the law, Congress has granted OFAC the authority to impose sanctions only on property, including any interest in property, belonging to designated individuals.
Smart Contracts Are Not Property
In a conclusion written by Judge Don Willett, the court ruled that the immutable smart contracts in question do not qualify as property, and therefore, OFAC cannot impose sanctions on them. The court determined that “since this element is dispositive, [it] need not address the other elements” involved in the case.
Judge Willett noted that “the district court erred by giving ‘heightened deference’ to OFAC’s interpretation of the term ‘property’ and concluding that immutable smart contracts fell within that definition.”
The court clarified that both under the plain meaning of the word “property” and OFAC’s regulatory definition, the term refers to something that can be owned. In this case, the immutable smart contracts in question did not qualify as property because they cannot be owned.
Implications for Cryptocurrencies
The court went further by making two conclusions that could significantly impact cryptocurrencies and smart contracts as a whole:
- Immutable smart contracts are not contracts despite their misleading name. The district court had previously ruled that these contracts are “simply a type of unilateral agreement using code,” but the Fifth Circuit Court disagreed, stating that “in making this determination, the district court disregarded basic principles of contract law.” The court explained that any valid contract requires at least two parties, but in the case of immutable smart contracts, “only one party is involved” because these contracts are “merely lines of code,” not entities capable of entering into agreements with others.
The Fifth Circuit clarified that its decision does not conflict with “blockchain precedent,” which recognizes that some smart contracts can indeed function as contracts in cases where two or more parties agree to an arrangement. However, with ownerless immutable smart contracts, “there is no party with whom to contract.”
- The immutable smart contracts are not services. Instead, they “resemble tools that are used to provide a service,” which is “not the same as being a service.”
It will be interesting to see how the incoming Trump administration approaches this matter. It’s possible that the new administration will agree that the Biden administration’s OFAC overstepped its authority by taking these unprecedented actions.
