US Sanctions and Blockchain Censorship: The Current State of Transaction Screening on the Ethereum Network Under OFAC Regulations

These illegal on-chain interactions at Coinbase are clearly visible. It is expected that sooner or later OFAC will need to face this problem and make a decision. This is also a relatively large potential impact on Coinbase and Ethereum.

Written by: Aiying

According to data from Labrys and Rated Network, since Ethereum switched from proof of work to proof of stake on September 15, 2022, approximately 42% of the block pairs in the Ethereum blockchain are included in the U.S. Treasury Department’s Foreign Assets Control Wallet addresses on the OFAC’s Specially Designated Nationals List (SDN List) were reviewed. In other words, these blocks will exclude or block transactions from wallet addresses that appear on the U.S. sanctions list. Earlier this week, the proportion of blocks performing such censorship was even closer to 50%. This shows that about half of the blocks in the Ethereum network are performing some form of transaction review according to the US sanctions list.

Unlike permissionless crypto networks like Bitcoin, OFAC-compliant relay nodes on Ethereum review wallet addresses that appear on U.S. sanctions lists.

MEV-Boost, the Maximum Extraction Value (MEV) tool from Flashbots, censors these wallets by default and many relay nodes use their default settings. MEV-Boost also outsources the block production of validators to a third-party market operated by itself, maximizing returns through quantitative trading strategies such as pre-trading, post-trading, and pinch trading, which may utilize ordinary Ethereum user.

Some examples of MEV-Boost relay nodes include Flashbots (the largest so far) as well as BlockNative, Manifold, Eden, BloXroute Max Profit, BloXroute Ethical, and BloXroute Regulated, among others.

This means that when Ethereum relay nodes (nodes responsible for disseminating transaction and block information) using MEV-Boost software process transactions, they will automatically filter out those listed on the U.S. OFAC’s Specially Designated Nationals List (SDN List). wallet address for transactions. Therefore, transactions from these addresses will not be included in the blockchain. Many relay nodes may choose to use MEV-Boost’s default settings, thereby implementing this censorship mechanism in their operations.

(Image courtesy of Mev Watch)

Relay operators complying with U.S. sanctions scrutinize which users can broadcast transactions on the Ethereum blockchain. Of course, those users who have been sanctioned by the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC), even if they cannot go through OFAC-compliant paths (such as certain cryptocurrency exchanges or verification nodes), they can still try to go through other non-OFAC-compliant paths. to execute their transactions. In other words, these users may look for trading platforms or network nodes that do not comply with OFAC sanctions regulations to complete their blockchain transactions, because these platforms or nodes will not filter or reject transactions based on OFAC’s sanctions list.

For example, Coinbase and Tornado Cash were sanctioned by the US government last year for providing currency mixing services to North Korea. But according to data from Tornado Warnings, Coinbase has verified 686 transactions related to Tornado Cash in the past two weeks. As a verification node on the Ethereum network, Coinbase confirms and adds these transactions to the blockchain.

This table shows how many blocks each validator proposed, including transactions that interacted (deposited or withdrawn) with the Torado Cash contract or TORN of all denominations. Source: Toni Wahrstätter

This is a bit embarrassing for OFAC, who seems to be turning a blind eye to Coinbase’s actions. However, these contract interactions are clearly visible on the chain. It is expected that OFAC will need to face this issue and make decisions sooner or later. This is also a relatively large potential impact on Coinbase and Ethereum.