Many people assume that cryptocurrencies are anonymous because they don’t require a bank account or use financial intermediaries. But while your identity isn’t necessarily known, every transaction includes two unique wallet addresses and appears on a public record (the blockchain). As a result, cryptocurrencies are much less anonymous than cash.
Some cryptocurrency projects attempt to improve anonymity through mixers that combine transactions or more fundamental design decisions that obfuscate wallet addresses. But recently, they’ve come under intense regulatory pressure after the Treasury sanctioned Tornado Cash, a popular Ethereum coin mixing service.
Let’s look at how crypto mixers work, why governments have an issue with them, and alternatives for privacy-conscious users.
Crypto mixers enhance the privacy of cryptocurrencies byobfuscating wallet addresses and transaction amounts
What is a Crypto Mixer?
A crypto mixer is a third-party service or protocol that blends cryptocurrency transactions from many users together before posting them to the blockchain. As a result, it’s impossible to determine the origin of any individual transaction. And some crypto mixers go a step further by depositing funds into newly minted wallets each time.
There are two reasons to use crypto mixers:
- Financial Privacy – Crypto users and investors may want to keep their financial transactions private. For instance, a wealthy investor might want to hide their actions to avoid tipping off the rest of the market. Or, a consumer might want to purchase something (legally) without anyone tracing the transaction back to them.
- Money Laundering – Criminals launder between $800 million and $2 trillion of ill-gotten funds annually. Since they obscure the origins of transactions, they can funnel money from criminal activities through legitimate-sounding businesses and pay themselves without raising suspicion.
The most popular crypto mixers include:
- Wasabi Wallet
How Crypto Mixers Work
Crypto mixers, like Tornado Cash, are typically decentralized smart contract protocols that accept token deposits from one wallet address and let you withdraw them to a different address. Other crypto mixers, like Blender.io, operate as centralized entities, where users can deposit tokens to a wallet address and receive tokens in a destination wallet.
When you deposit a token, you receive a secret code that you need to withdraw the funds later. The platform then mixes tokens from various users to break the on-chain links between senders and recipients. When you withdraw funds, you specify a wallet address and provide the secret code, which acts as the private key for the transaction.
Crypto mixers typically charge transaction fees ranging from 0.05% to 2.5%+. The protocols or platforms deduct these fees from the amount sent to the destination wallet. In addition to these costs, crypto mixer transactions have significant delays, increasing the gap between input and output and making transactions harder to stitch together.
Regulatory Risks & Penalties
Crypto mixers are an obvious way for criminals to launder money, making them a target for U.S. and global regulators.
In May 2022, The U.S. Department of the Treasury sanctioned Blender.io after North Korea’s Lazarus Group used it to launder $20.5 million in proceeds from the $620 million Axie Infinity heist. The sanctions prevent anyone in the U.S. from transacting with Blender.io or any entities owned directly or indirectly by blocked persons.
Then, in August 2022, the Treasury sanctioned Tornado Cash, saying that it helped launder $7 billion of virtual currency since its inception in 2019. In particular, the government alleges that it helped launder over $455 million stolen by the Lazarus Group. Like Blender.io, the move prevents anyone in the U.S. from transacting with Tornado Cash.
In October, Coin Center and others filed a lawsuit against the Treasury, saying they exceeded their statutory authority in sanctioning crypto mixers because they are a “privacy tool beyond the control of anyone.” Coinbase CEO Brian Armstrong also argued that the sanctions would harm innocent people, remove privacy, and stifle innovation.
Several crypto mixers remain unsanctioned, but they could experience problems in the future. When sanctions happen, the U.S. government freezes assets in the entity or protocol, making it difficult to retrieve funds without a special request. And sanction violations – even unknowingly – could trigger fines of more than $300,000 per transaction.
Alternatives to Consider
Crypto mixers represent just one of many ways to enhance the privacy of cryptocurrency transactions.
Privacy coins, like Monero or Zcash, use stealth wallets, zero-knowledge proofs, and other techniques to keep cryptocurrency transactions private. For example, Monero uses one-time-use “stealth addresses” for each transaction and “ring signatures” that group genuine transactions with older decoy transactions to make them impossible to trace.
The most popular privacy coins include:
While privacy coins remain legal in the United States, they have come under scrutiny elsewhere and could become a future sanctions target. For example, Japan banned privacy coins entirely, while Australia and South Korea banned exchanges from offering them. Moreover, new European know-your-customer (KYC) laws could jeopardize them.
The Bottom Line
Crypto mixers enable anyone to keep transactions private by mixing deposits with other transactions before withdrawing funds. Unfortunately, these tools are ideal for money laundering, making them a target for government regulators. As a result, crypto users may want to tread carefully when using them until there’s more legal clarity.
If you trade crypto assets, ZenLedger can help aggregate transactions across wallets and exchanges, compute your capital gain or loss, and populate the tax forms you need each year. You can even find tax loss harvesting opportunities to reduce your tax bill.