Cryptocurrency mixers: what use and what regulatory framework?

On August 8, Tornado Cash, a cryptocurrency mixing service, was blacklisted by US authorities following suspicions of money laundering. This event had an important resonance in the cryptocurrency market. Thus, to understand its influence on the industry, it is important to clearly define what a cryptocurrency mixer is, how it works and why illicit actors use it.

Use cases for cryptocurrency mixers

A cryptocurrency mixer is a service that mixes cryptocurrencies from various users in order to hide the origin and ownership of the funds. Cryptocurrency mixers are mainly used by people who want a high level of confidentiality in their financial activities. Financial privacy is of particular interest to people in countries with oppressive regimes who want to conduct legal transactions anonymously. Unfortunately, even though cybercriminals represent a small part of their users, mixers are also used for money laundering. Indeed, malicious actors use it to hide the connection between cryptocurrency wallets to collect their illegally obtained earnings and the wallets from which they transfer their funds to exchanges. This way, they manage to bypass anti-money laundering alerts.

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The different types of cryptocurrency mixers

Mixers collect, aggregate and mix cryptocurrencies deposited by users in different ways. Then, funds can be withdrawn from new addresses, for a small service fee. Tracking deposited funds is then more complicated because users can schedule amounts to be withdrawn at random intervals. It is also possible to conceal its use of a mixer by varying the transaction fees and the type of withdrawal address.

There are three main categories of mixers:

Centralized mixers of the “custodian” type which temporarily take possession of users’ funds and are generally managed by a single operator. Knowing that this type of mixing service is both centralized and custodial, users face additional privacy risks. Moreover, they are often the target of law enforcement since financial law enforcement agencies consider them to be unregistered money services businesses.

CoinJoins which are commonly integrated into privacy wallets, i.e. cryptocurrency wallets with increased privacy that mixes cryptocurrencies from different users in a single transaction. Unlike centralized mixers, CoinJoins never hold user funds.

Smart contract mixers (or “smart contracts”) that do not have a cryptocurrency custody service and do not mix user funds in a single transaction. The user sends their funds to the mixer, receives a cryptographic note that they own it, and then sends it back when they want to withdraw the funds to a new address.

Mixers: between regulatory obligations and user requirements

In the United States, for example, the Financial Crimes Enforcement Network (FinCEN) believes that centralized companies offering cryptocurrency mixing services must register as money transmitters under the Bank Secrecy Act (BSA). On the other hand, they have three main obligations. They must register with FinCEN, maintain an anti-money laundering and know-your-customer compliance program, and meet all reporting and record-keeping requirements. So far, few if any mixers seem to follow these rules. Indeed, since respect for privacy is the main reason why many users use mixers, it is unlikely that they will implement these procedures at the risk of losing users.

This year, the use of cryptocurrency mixers is expected to reach all-time highs. However, market players are still divided on the subject. On the one hand, mixers are recognized for their ability to effectively guarantee user privacy. But on the other hand, the large proportion of mixed funds coming from illicit addresses raises the question of the perverse effects of their service. Therefore, it is essential that public and private sector actors reflect together on the best way to assess and manage the risks associated with mixers.

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Cryptocurrency mixers: what use and what regulatory framework?

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