Weekly Top Stories - 11/29

This week in the newsletter, we write about a major victory for Tornado Cash in court, President-elect Donald Trump's transition team, and the introduction of a decentralized block-building solution on Ethereum.

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Court Rules in Favor of Tornado Cash

5th Circuit overturns sanctions against Tornado Cash smart contracts. In a court case brought by users of Tornado Cash appealing a district court ruling against the smart contract platform, the U.S. 5th Circuit Court of Appeals ruled against the U.S. Treasury Department, finding that Treasury overstepped its authority when the Office of Foreign Asset Control (OFAC) added the Tornado Cash smart contracts to the "Specially Designated Nationals" (SDN) list, also known as the "sanctions list."

In the decision to reverse and remand to the District Court, the judges wrote that "the immutable smart contracts at issue in this appeal are not property because they are not capable of being owned." The judges continued, "Simply put, regardless of OFAC's designation of Tornado Cash, the immutable smart contracts continue operating." Finally, the court wrote that "contrary to the [Treasury's] arguments, the immutable smart contracts are not services… even when we consider OFAC's regulatory definitions, the immutable smart contracts are not property because they are not ownable, not contracts, and not services."

Paul Grewal, chief legal officer at Coinbase, which funded and supported the lawsuit, called the ruling "a historic win for crypto and all who care about defending liberty." Neeraj Agrawal, head of communications at CoinCenter, the industry think tank that also supported the case, noted that the 5th Circuit's decision "validated in court" the legal arguments made by CoinCenter in the lower court case.

The extent to which this ruling will assist Roman Storm, founder of Tornado Cash, in defending the Department of Justice's allegations against him is still limited. The 5th Circuit ruling specifically rejects OFAC's addition of Tornado Cash smart contracts to the sanctions list, but it doesn't address the allegations that Storm conspired with or facilitated transactions from sanctioned entities through the Tornado Cash front-end, which are among the DOJ allegations against him. Earlier this month, Storm's expected December trial was delayed by a New York judge until April.

OUR TAKE:

This is a big win at the second highest tier of the federal court system for immutable smart contracts. In an August 2022 Galaxy Research report, we speculated that "it's possible that OFAC considers Tornado Cash an 'anonymizing service provider' rather than 'anonymizing software.'" That is ultimately the position taken by Treasury in this case and the one specifically struck down by the appellate judges in this case.

It's great that the judges ruled that Tornado Cash smart contracts are not property because it makes it impossible from a statutory perspective for OFAC to sanction them, but their reasoning is also important and instructive. The court's finding that the smart contracts' lack of upgradeability and control by any party renders it impossible for them to be sanctioned draws a bright line that both protects and promotes decentralization in DeFi. There are debates among crypto policy advocates and policymakers about where that line should be and the extent to which mutable contracts should be excluded from sanctions authority, but at a minimum, open source, decentralized, immutable software that cannot be controlled must be excluded. This not only preserves a viable pathway for smart contract developers to deploy code without fear that its uses by bad actors could render the code illegal, but it also represents a reasonable and very American viewpoint on the nature of expression in the digital age.

Stepping back, though, there are not many applications in DeFi that fit Tornado Cash's mold. Uniswap is probably the closest and most prominent (irrespective of the fact that UNI holders actually can vote on and enact one upgrade, the "fee switch"), as its contracts cannot be meaningfully upgraded (certainly not to enact censorship) and they cannot be halted. But many other smart contracts and bridges, let alone L2 sequencers, are likely decentralized in a way that the 5th Circuit's reasoning would apply. While the 5th Circuit's ruling on OFAC sanctions authority is important, other agencies have raised similar policy questions that are not addressed by the court, such as the IRS' Broker Rule (in which the agency similarly wonders the extent to which decentralized applications would be covered) and the SEC's "exchange" definition. Although the ruling doesn't apply to these issues, the reasoning could be used as a basis for a whole-of-government approach to these issues in the new Administration, and that would be a strong base upon which to build more durable policy. - Alex Thorn

President-Elect Trump Transition Team Signs Agreement to Begin Takeover from Biden Administration

President-elect Donald Trump's team announced on Tuesday that it had signed the White House agreement, a key step in transferring control of the federal government to its incoming administration. The announcement was also confirmed by White House spokesperson Saloni Sharma. The completion of the agreement between President-elect Trump and President Biden's administration will soon give Trump transition officials access to federal agencies. This access will allow Trump's team, including his cabinet nominees, to prepare for their takeover and receive briefings on current government affairs. More importantly, the agreement's completion formally initiates the peaceful transfer of power between the two administrations.

Still missing is the completion of the memorandum of understanding (MOU) with the General Services Administration. The signing of this document would grant funding, office space, and technology to Trump's incoming administration during the transition period. However, President-elect Trump has stated that his transition will be privately funded and that his team will use an existing ethics plan in place of the GSA agreement.

Scott Bessent, hedge fund manager and noted Bitcoin bull, was named last Friday as President Trump's nominee for Treasury Secretary, while former SEC Chair Jay Clayton was picked as the U.S. Attorney for the Southern District of New York (SDNY), a key law enforcement position. Paul Atkins, another former SEC Commissioner, current Commissioners Mark Uyeda, and Hester Peirce, and former SEC General Counsel Bob Stebbins have been floated for SEC chair, but no announcements have been made.

OUR TAKE:

The selection of Scott Bessent as Treasury Secretary marked the end of one of the most interesting cabinet official selection processes in recent times. Bessent, a successful and well-known hedge fund manager, was seen by markets as a strong choice both for Wall Street and for managing the country's finances generally, but he's also a supporter of Bitcoin and digital assets. He told Fox Business in July that "crypto is about freedom and the crypto economy is here to stay."

While Robinhood Chief Legal Officer and former SEC Commissioner Dan Gallagher publicly removed his name from contention for the SEC Chair position, the remaining reported contenders would likely all be supportive of a more progressive approach to the regulation of digital assets, including floated names Paul Atkins, Dan Stebbins, Mark Uyeda, and Hester Peirce. While recent reporting suggested that President Trump's team favors the CFTC to lead digital assets regulation over the SEC, nonetheless the CFTC doesn't currently have the authority to regulate any spot markets, crypto or otherwise, so this should be seen (for now) as a nod to Congress as it contemplates various market structure bills (such as FIT21 or DCCPA). We expect the Trump transition team to begin picking and announcing nominees to lead the various market and banking regulators in the coming weeks, with most of the Senate-confirmable roles named before the end of the year.

With the agreement finally signed between Trump's team and the Biden White House, nominated cabinet officials and their teams will begin landing inside the agencies to assess the state of policies and personnel over the coming weeks. These teams will catalog the state of play in the various agencies and departments and begin to build a roadmap for both personnel decisions and early policy moves ("the first 100 days") the Trump administration can take to get its agenda moving after the Inauguration on January 20. - Alex Thorn & Zack Pokorny

Introducing BuilderNet on Ethereum

On Tuesday, November 26, Flashbots Product Lead Shea Ketsdever unveiled a novel solution for decentralized block building on Ethereum called BuilderNet. Roughly 90% of Ethereum blocks are built by two pseudonymous entities, Beaverbuild and Titan Builder. BuilderNet aims to improve the decentralization of Ethereum's block-building market by tackling the problem of exclusive order flow deals.

The main reason there is a duopoly in the builder market is because Beaverbuild and Titan Builder have off-chain agreements with order flow providers, primarily DEX aggregators like Cowswap and 1inch, that give them an advantage in building high-value blocks. BuilderNet uses hardware called Trusted Execution Environments (TEEs) to facilitate the sharing of private order flow across multiple builders.

The first release of BuilderNet is live on Ethereum and operated by a permissioned set of three builders, Flashbots, Beaverbuild, and Nethermind. In the future, the idea is to allow any builder to permissionlessly join BuilderNet and get access to the order flow submitted to this network. Wallets, apps, users, and searchers are incentivized to send order flow to builders on BuilderNet because they can share in the MEV and gas fees generated based on their transactions.

OUR TAKE:

One of the core theories being tested through the launch of BuilderNet is the pragmaticism of decentralizing the builder market for both small and large builders. For BuilderNet to succeed in tackling the problem of private order flow, it must convince existing builders that they can create blocks with higher value on BuilderNet than through curating their private order flow.

For small builders without much capital, reputation, and resources, competing for private order flow against large builders like Beaver and Titan is difficult and even futile. So, the possibility of accessing a shared pool of order flow through BuilderNet is a welcome alternative. For large builders, BuilderNet could allow these entities to specialize further in other aspects of competitive block building like searching, and earn greater profits from these skills rather than from exclusive deal-making.

However, given that capturing exclusive order flow is currently the largest barrier to entry into the builder market, incumbents in theory would not be keen on letting go of this advantage by participating in BuilderNet. This is why the support of Beaver, one of the two largest builders on Ethereum, in BuilderNet, is notable and important. It signals that a decentralized block-building market may not only be healthier for Ethereum's credible neutrality and censorship resistance but also a way to pragmatically grow MEV profits for all builders through shared order flow and eventually, shared block-building. - Christine Kim

Charts of the Week

Aggregated onchain stablecoin borrow rates and stability fees are nearing the all-time high of 15.4% using the seven-day moving average set in April of 2024. This comes after seven months of rate compression and "chopsolidation" in crypto prices. Onchain rates are historically reflexive to the cryptocurrency market, chasing prices higher in bull markets and following them down in bear/ sideways markets. The intensity of the increase in onchain rates coincides with the aggressive move in the prices of prominent cryptocurrencies since the U.S. Presidential election on November 5. Since then, bitcoin is up 42%, ETH is up 51%, and memecoins have seen an explosion in activity and prices.

The last time stablecoin rates were this high in aggregate the amount of USDC, USDT, and DAI borrowed on Aave and Compound was around $3.3 billion with a utilization rate (the share of stablecoins deposited onto the applications actively being borrowed) at 90%. Today there is $4.8 billion in open borrows on these stablecoins with a utilization rate of around 93.9%. The last time these markets saw this many deposits and outstanding borrows was in May 2022 as the market began to unwind itself in the face of the Terra and UST collapse. The recent climb in stablecoin borrowing activity is a positive sign of demand in onchain markets.

Other News

• Court denies "faketoshi" Craig Wright's appeal in Bitcoin creator case

• Vitalik Buterin donates $1m to CoinCenter following Tornado Cash ruling

• Phantom wallet adds support for Base blockchain

• Ripple donates another $25 million to pro-crypto super PAC Fairshake

• MicroStrategy makes largest-ever bitcoin buy, adding $5.4 billion worth

• Tether shutters Euro stablecoin EURT

• Deutsche Bank invests in blockchain payment network Partior

• Trump's crypto project gets $30M investment from Justin Sun

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