Fifth Circuit Overturns OFAC Sanctions on Blockchain-Based Privacy Technology
By A.J. S. Dhaliwal, Mehul N. Madia, and Maxwell Earp-Thomas of Sheppard, Mullin, Richter & Hampton LLP
On November 26, 2024, the U.S. Fifth Circuit Court of Appeals delivered a significant ruling, overturning sanctions imposed by the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC).
The sanctions targeted a decentralized cryptocurrency mixing service, a blockchain-based technology designed to enhance transaction anonymity. OFAC had placed the crypto mixer on the Specially Designated Nationals and Blocked Persons (SDN) list, prohibiting U.S. persons from engaging in any dealings with it. The regulator’s action stemmed from the assertion that North Korean hackers used the crypto mixer to launder hundreds of millions of dollars in illicitly acquired funds.
The court’s decision hinged on the nature of the crypto mixer’s operations. The court’s reasoning was that because the crypto mixer’s immutable smart contracts function autonomously, they do not qualify as “property.” Therefore, OFAC was deemed not to be empowered to regulate them under the International Emergency Economic Powers Act (IEEPA).
IEEPA authorizes the President to freeze the assets of, and prohibit transactions with, any foreign actor determined to be a threat to U.S. national security. The Fifth Circuit concluded that OFAC had exceeded its statutory authority under the Administrative Procedure Act. OFAC sought to circumvent the IEEPA’s ownership requirement by arguing that the crypto mixer profits from, and thus has an interest in, the underlying computer code comprising the smart contracts. The regulator compared the smart contracts to patents and copyrights, which OFAC considers property.
The court disagreed, pointing out that, due to the decentralized and autonomous nature of smart contracts, they cannot be owned, controlled, or even altered by their creators. Because OFAC’s definition of property requires it to be ownable, the smart contracts fall outside the agency’s jurisdiction.
The ruling highlights the need for legislative clarity. The court noted that the power to regulate such innovations lies with lawmakers, not solely with executive agencies acting under statutes enacted before the advent of the internet and digital technologies.
Putting It Into Practice:
This case establishes a precedent for how regulators might address decentralized technologies in the future. While it clarifies the regulatory landscape for the crypto industry, it also underscores that developers and users of blockchain applications will face regulatory scrutiny if their technologies are used for illicit activities. This ruling is expected to amplify calls from the crypto industry for a modern legal framework that promotes financial innovation.
