Payments companies are regularly punished for engaging in money laundering. MoneyGram, for instance, has has to pay multiple fines. Western Union was famously busted in 2017. Meanwhile, Cash App is being probed as we speak for inadequate anti-money laundering controls.

In the future, these companies may have in their grasp a very simple techno-legal trick that allows them to deal with dirty money and get away with it. All they need to do is transfer their entire IT apparatus from a regular set of databases onto "immutable" smart contracts hosted on blockchains.

This, at least, is what happens when you take the arguments put forward by the Tornado Cash defence team to their logical conclusion.

If you follow this blog, you'll know I've written a lot about Tornado Cash.

Cryptocurrency isn't private; it's radically transparent. The function that Tornado Cash serves is to accept traceable crypto from users, both licit and illicit, and return it to them in untraceable format. Beginning in late 2020, a steady stream of stolen crypto began to be moved by thieves onto Tornado Cash for the purposes of obfuscation. In effect, money laundering was now occurring on the platform. But who were Tornado Cash's money launderers? More specifically, someone was to blame for helping these thieves to disguise their tracks – who was this someone?

Last August the U.S. government indicted two people involved with Tornado Cash for conspiracy to commit money laundering.  I wrote about the government's indictment here. (They were also indicted for conspiracy to evade sanctions and the operation of an unregistered money transmitting business, but that's another story.)

Roman Storm and Roman Semenov, the accused, wrote the original smart contracts for Tornado Cash and exercised a degree of control over a key website for accessing those smart contracts. The government alleges that Storm and Semenov knew that the property being transferred to Tornado Cash was criminally derived, and that they also knew that the hackers wanted to disguise its source. Yet the duo conducted the financial transactions anyways. These three elements – knowledge, the conducting of financial transactions, and the presence of unlawful money – are key ingredients to building a money laundering charge. (See specifically 18 U.S.C. § 1956(a)(1)B(i).)

Last week the defence lawyers for one of the accused parties, Roman Storm, filed a motion to dismiss the case, giving observers some initial insights into what arguments will be used to try and beat the government's money laundering charge. As I'll show, assuming these arguments are right, then a big chunk of the existing payments system has a fool proof plan for avoiding money laundering laws.

The distinction between the Tornado Cash front end and the actual Tornado Cash smart contracts looms large in the case, so let's touch on that briefly. The smart contracts are bits of code that reside directly on the Ethereum blockchain. This code allows users to deposit their trackable crypto to a pool along with many other users and then withdraw it, obfuscated. A front end, by contrast, is a regular website that allows users to interact with the smart contracts, and is hosted through a normal internet provider .

While users are free to interact directly with the Tornado Cash code, the most popular way to access Tornado was allegedly via the intermediation of the main website that was under the control of Storm and his colleagues.

The key argument made by Storm's lawyers is that the accused are not subject to the money laundering statutes because the money laundering statutes only apply to people who "conduct" what are defined as "financial transactions," and Storm did not conduct financial transactions.

The defence says that in order to show that someone was conducting a financial transaction it must be the case that control was exercised by that person over the actual criminally-derived funds. Storm may have had some control over the front end, but the defence claims this doesn't really matter because the front end itself did not exercise any control over the proceeds. "It did not access the funds directly," the lawyers argue. "It merely provided an interface to permit a user to interact with the smart contracts."  

As for the smart contracts, Storm clearly had no control over them. He had relinquished control back in May 2020, when a trusted setup ceremony ensured that no further changes could be made to the code. At that point, the smart contracts worked automatically. Bad actors only discovered Tornado Cash several months after the ceremony, at which time Storm had long gone. Furthermore, the smart contracts didn't actually control the funds, say Storm's lawyers, it was users of Tornado Cash who controlled the funds within the pool.

So, there you have it. The government's money laundering charge against Storm and Semenov requires locating a person or institution who is in control of the dirty funds and conducts financial transactions with them, says the defence. But it isn't the accused who exercised this control, it is the users who did so, via the intermediation of a set of financial automatons, the smart contracts.

For the philosophically crypto-pilled, the defence's arguments will make sense, since according to this view crypto is a revolutionary force for good, one destined to "break" what they see as a corrupt and old-fashioned financial system. For this breaking to happen, crypto shouldn't be forced to conform to the same old laws as stodgy payments companies like Western Union. New laws, or new ways of looking at old laws, should be shaped around crypto.

But to the non-crypto pilled, a successful defence of Storm and Semenov is quite concerning. As described by Bruce Schneier and Henry Farrel, it could potentially mean that anyone who wants to facilitate illegal activities would have a strong incentive to copy Tornado Cash, effectively turning their operation into a "golem" – a deathless artificial being run on smart contracts – and then throwing away the keys to avoid the law.

More specifically, by shifting their entire IT infrastructure over to smart contracts or some other equivalent automaton, payments institutions like MoneyGram that are currently subject to the money laundering statutes (and have already been punished under them several times) might be able to avoid future prosecution. If criminals start using the autonomous MoneyGram robot to make payments, MoneyGram can simply say: "The robot allowed them to do it, not us!" As for the official MoneyGram front end, even if the mob becomes a happy customer MoneyGram needn't worry since the front end is nothing but a filmy gauze between users and the autonomous robot, the company never actually controlling the funds (although according to the Tornado Cash lawyers the front end can continue to safely generate a profit for its owners!)*

The money laundering statutes – 18 U.S.C. § 1956 and § 1957 – are two of democratic society's key legal bulwarks against criminal behaviour. In a world in which the Tornado Cash defence prevails and payments companies adopt it as a techno-legal shield against money laundering charges, 1956 and 1957 become much less effective – and not because we decided to soften them via a democratic process, but because financial institutions found sneaky ways to get around the rules.

Mind you, the money laundering statutes wouldn't disappear entirely. The Tornado Cash defence's point is not that there is *no* money launderer. Rather, their argument is that it is the users of Tornado Cash, the public, who had "exclusive control," and not Storm and Semenov, so the latter duo aren't the guilty parties. Taking this control theory further, if the government wants to charge anyone with money laundering, it should probably be trying to target folks like Vitalik Buterin, a member of the public who regularly put his funds into Tornado Cash and thus potentially participated in the concealment of unlawful proceeds deposited by criminals.

What a dangerous financial tool to make available to the public!

Right now, I can safely transfer $1000 to Western Union without having to worry about commingling my $1000 with a criminal and thus facing a potential money laundering charge. The company takes on that liability for me. But if Western Union stops performing this legal responsibility by building financial automatons to which everyone has open access, both good and bad actors, then I am suddenly at risk of being a counterparty to criminals when I transfer $1000 to Western Union, and that could turn me into a money launderer. Money launderers can face up to 20 years in prison.

For users, a Western Union transfer suddenly becomes the financial equivalent of handling nuclear waste or operating a five-story crane. It's a task most people can't, and shouldn't, handle. Given the inherent legal risks, it's possible that the market will never widely adopt financial services delivered in the form of robots or golems or immutable smart contracts, preferring to stick with the traditional safe intermediaries who take on the burden of compliance. Or not?

Storm's lawyers may win this particular case. Their logic certainly seems sound, but I'm no lawyer. If so, there's a good argument to be made for lawmakers to consider modifying the definitions of words like "conducting" and "financial transactions" found under the money laundering statutes to prevent future efforts to use the Tornado Cash techno-legal trick. If  by merely swapping the technology used to deliver financial services a payments institution can suddenly avoid the law and offload legal responsibility onto users, that's probably a hole that needs closing.

* MoneyGram would still be able to financially profit from the combination of smart contracts and a front end, much like how Storm and Semenov did with Tornado Cash, by finding canny ways to use their control over the front end. According to the indictment, Storm and Semenov, along with others who had control over the front end, curated a list of "relayers" – third parties who provided users with bolstered privacy protection – and then extracted resources from relayers who wanted the privilege of getting on the list.

This profit motive can't help prove that Storm was engaged money laundering, says the defence, since there are many examples of criminals using "lawful tools for unlawful ends," and even though the tools' developers have "profited from that use" those developers were not punished.

The model of finance I've been using for many years is the fairly dismal dark forest model. The financial industry is a shadowy forest full of sly foxes waiting to prey on retail investors. The list of sly foxes is long: all sorts of Samuel Bankman-Frieds, IRS scammers, internet ponzi schemers, stock con-artists, bankers hocking high-fee products, fly-by-night gold mine promoters, and shady crypto platforms. It's truly horrifying out there.

So why not implement mandatory high school financial literacy classes to upgrade the retail class's defences against this dark forest?

My first concern is that high school students can only absorb so much. Mandatory financial literacy classes will inevitably come at the expense of learning other very important things like math, writing, and science, which are at the base of so many vital disciplines.

Second, while I'm sure financial literacy classes might help a bit to protect us against the dark forest, I don't think they'll do much. The prototypical retail investor's single biggest weakness is that we are all incredibly busy people. As we rush through the dark forest we simply don't have enough time to familiarize ourselves with its many arcana. This incapacity to pay sufficient attention makes us easy pickings, no matter whether we've had a few financial literacy classes or not.  

The dark forest preys not only on our rushed lives, but also our need to keep up with the Joneses, our precarious and stressful financial situations, and our worries for loved ones. I'm just not convinced that a few years of high-school financial literacy classes will release us from these eternal and very-exploitable emotions.

Luckily, we have two other major defences against the dark forest: the competitive market and the government.

The government can make the dark forest safer by flushing out bad actors and pushing fraudsters to the nether regions, then nudging us retail investors towards the parts made safe. It does so by regulation, standard investor protections, licensing requirements, and through law enforcement and the court system.

As for the market, its competitive nature gives rise to a class of trained and experienced financial professionals who are generally equipped to lead retail investors through the dark forest.

If we get these two defences right, then we can afford ourselves a great luxury: a retail investor class that gets to remain relatively ignorant of finance while being safe in its ignorance. This ignorance is a thing of beauty. Instead of folks having to waste time and energy learning about the forest's fox population, its patois, and its dangerous pathways, they can focus on their own very busy lives, families, studies, hobbies, and careers. That's what we want them to do. We don't want a world where the average person needs to give up an hour or two each week slogging through financial literacy 101. We want them to blithely use financial products and take for granted they will be safe, and then get on with more important things.

Alas, if we get these two defences wrong, then we get disasters like Sam Bankman-Fried's FTX, which destroyed the financial lives of thousands of innocent retail investors. 

What happened with FTX? In the case of FTX's offshore exchange, there was a complete absence of government regulation. Not so FTX's US arm. Alas, FTX-US operated under a bare-bones regulatory framework courtesy of state licensing boards, which are simply not appropriate for overseeing a trading venue like FTX, and are more equipped for watching over remittance companies like Western Union. (See my article Let's stop regulating crypto exchanges like Western Union.) This was the dark forest at its darkest.

To see how see this first line of defence can be properly deployed, take a look at what happened in Japan when FTX collapsed. FTX's Japanese customers were made 100% whole a few months after the debacle. (American ones are still waiting). That's because Japan got things right and forced FTX Japan to adopt appropriate regulation, effectively preventing the sly fox Bankman-Fried from preying on Japanese citizens. (See my article Six reasons why FTX Japan survived while the rest of FTX burned.) 

The second defence against predators like Sam Bankman-Fried, a market-supplied legion of trained and experience financial professionals, was lacking, too, since stuff like dogecoin and dogwifhat is outside the ambit of the financial professional class, and deservedly so. Had seasoned institutional investors and other financial professionals been operating in the sector, they would have used their training to suss out the FTX fraud much earlier, guiding folks away to safer exchanges.

The two defences entirely lacking, the result was a wave of innocent retail investors left free to venture into into the dark forest. But mandatory financial literacy classes don't fix this. Government regulation and elite financial professionals do. 

Last month American provocateur Tucker Carlson visited a Russian grocery store. Because it was filled to the brim with food, Carlson claims that western sanctions placed on Russia aren't having an effect. "We've been told sanctions on Russia have had a devastating effect on its economy," writes Carlson. "We visited a grocery store in Moscow and found a very different situation."

Tucker Carlson We've been told sanctions on Russia have had a devastating effect on its economy. We visited a grocery store in Moscow and found a very different situation. pic.twitter.com/oPF1WUE6Ec

— 1776 (@TheWakeninq) February 15, 2024

Don't let the videos fool you. Sanctions have had a big effect on Russia. And by sanctions I'm referring not only to the official sanctions levied by coalition governments, but also self-sanctions imposed by Western companies. Self-sanctioning occurs when companies like Lego, Coke, or McDonald's choose to leave Russia, not because their government says they must, but because their customers and employees have pressured them to leave, or out of a general sense of solidarity with Ukraine. (Here is a list of companies that have left.)

While Carlson and Feenstra's videos of store shelves suggest prosperity, what they don't show is how many resources Russian businesses have been forced to sacrifice in order to re-order their affairs so as to provide Russians with full shelves. These businesses have had to go out and build new relationships with manufacturers in places like China or Turkey. The alternative products that have been introduced often aren't as good, or as familiar, or as useful to customers. 

Many of the "sanctions don't work" videos spotlight the contraband Western goods that are often found on Russian store shelves. This video, for instance, shows Coke being sold at Spar, a grocery store. Coke is banned in Russia, so the message here is presumably that the sanctions are a waste of time. But what they don't show is that the prices for these contraband goods will be higher than before. The Coke products in the video are no longer made in Russia but must be smuggled in via third-parties such as Poland, Afghanistan, and Kazakhstan, the extra shipping and handling costs being incorporated into their final price. Think of this as a sanctions-induced smuggling tax.

Put differently, coping with sanctions and self-sanctions is costly for Russia; in Carlson's videos we only see the final product, full shelves, but not all the hassle and resources that have gone into producing that state of affairs. Nor is the set of full shelves on display in his video necessarily as desirable as the set of full shelves that existed prior to sanctions.

A much more realistic illustration of the effect of sanction is provided in a recent video by Arend Feenstra, the Dutch-Canadian farmer, of a visit he makes to a Russian tractor dealership.

I watched it so you don't have to. What follows is a quick summary of the relevant bits. It starts out with an excited Feenstra driving out to is what he believes to be a Case/New Holland dealership. Since the Case and New Holland tractor brands are popular in Canada, Feenstra's previous home, he will get to see some brands that he is familiar with. Ah, nostalgia.

(A side note: As a Dutch-Canadian myself, I find it jarring that someone of my ilk has decided to emigrate to Vladimir Putin's Russia. But digging deeper, we learn that Feenstra is a bigot: he doesn't like the LGTBQ community. Given that Russia's regime considers the "international LGBT movement" to be a terrorist organization, I suppose there's a natural fit for folks like him in Russia.)

Unfortunately for Feenstra, when he arrives at the dealership he discovers that it no longer sells Case or New Holland tractors. Both brands of farm equipment are built by CNH, a UK-headquartered equipment manufacturer, and along with most other Western farm companies CNH pulled out of Russia in 2022, effectively ending all its Russian dealership relationships. 

The only new tractors that the dealership has available are Chinese-built YTOs, which the dealership was forced to turn to in 2022 to fill the sudden gap in its show room.We learn in the video that YTOs are a regression in terms of technology. Feenstra points out throughout that the Chinese tractors have less electronics than their western equivalents and more mechanical parts. Instead of electronic shifting, for instance, the YTOs use mechanical shifting. The fuel pumps are mechanical too. It's like stepping back in time.

A regression to mechanical components is a nuissance, but it's not awful. However, things get worse. Enter the triple mower problem.

A tractor with a triple mower

Prior to the sanctions, we learn that the dealership's most popular tractors were larger horsepower products like the New Holland 210. These larger tractors are particularly desired by farmers in the region for their ability to accept an attachment known as a triple mower, says the employee. A triple mower is designed to cut a wider swath of grass or crops compared to a single mower. This allows farmers to cover more ground in less time, improving overall efficiency during harvesting or haymaking operations.

Alas, the Chinese-made YTOs can't use a triple mower, the employee tells us. The dealer is in talks with the manufacturer to make changes to the frame to accommodate them, but there's no indication when this will occur. Feenstra is not impressed by any of this.

Feenstra checking out a YTO tractor

But another video (see below) suggests the opposite. In it the Australians are paying a visit to a nearby John Deere tractor dealership. We learn from an employee that this particular dealership is part of a Russian dealership network that, prior to the sanctions, was the largest John Deere distributor in all of Europe. John Deere is a U.S. equipment manufacturer.

Near the start, John optimistically films a large sign boasting the dealership's many relationships with western manufacturers, including JCB, Pottinger, Väderstad and Haybuster. But as he learns later on, the sign is no longer meaningful. Along with most other farm product companies, John Deere and JCB exited Russia in 2022. The dealership has lost its dealer status and can no longer sell either John Deere or JCB products, nor most of the other brands that are advertised on its sign.

To fill the void, the dealership now offers Turkish-made Basak tractors and Chinese-made Noma tractors. An employee who shows the family around the dealership grouses to John about the quality of the Chinese tractors that he stocks, saying: "I don't know what we will do with it, because if I sit inside of the cabin and look down I can see the ground because there in a gap in the floor." The tractor is the technological equivalent of a first generation John Deere, he complains.

Interestingly, the owner of this particular network of Russian dealers, known as EkoNiva-Technika, is based in Germany and produces public financial statements. I dug through the numbers to get a better feel for how the dealership is doing. 

In 2021, prior to self-sanctions, the EkoNiva-Technika dealership network sold 403 tractors. Then Russia invaded Ukraine, and the dealership's sales fell to 263 tractors in 2022. In 2023 it sold just 131 tractors. That's a big fall.

The German parent blames the decline in tractor sales on a "significant drop in demand" for new agricultural machinery by Russian farmers, as well as the loss of its main suppliers, which were replaced by alternatives from China and Turkey whose "products fell far short of the previous sales figures." Meanwhile, the dealer's spare parts business saw a big jump in revenue thanks to an intensification in demand for Western parts and higher parts prices, no doubt due to having to resort to costly transshipment routes. Spare parts have gone from 24% of the dealership network's revenues prior to sanctions to 49% of revenues in 2023.

Back to John, the Australian farmer. When he does eventually buy a tractor, we find out that it's a used Japanese-made Yanmar tractor. All the controls are written in Japanese and he can't read the manual. Compounding matters, Yanmar has officially left Russia, so John will likely find that getting parts is a pain. Again, that's the nuissance of sanctions. Rather than getting the first-best, the only option is often second- or third-best.

John and his new Japanese tractor

Given all the anecdotes I've assembled, what is the bigger picture?

Prior to being sanctioned, Russia's farming sector had evolved towards a particular pattern of specialization and trade comprised of middlemen dealerships, their relationships with Western manufacturers, and the farmers they served. The sanctions (and self-sanctions) immediately upended that pattern, forcing dealers and farmers to undergo a massive and costly recalculation event.

The new pattern of specialization and trade that the Russian farm sector has arrived at doesn't appear to be as good as the initial pattern. 

To begin with, the alternative brands that have filled the void seem to be a downgrade. The Chinese YTOs that the first dealer is selling won't accept a triple mower while the tractors the second dealer stocks have holes in the floors. Spare parts that were once widely available thanks to dealerships' stable relationships with their western suppliers are harder to come by. Dealership resources are now being diverted to smuggling in contraband parts, which means higher prices for farmers. Finally, as suggested by the dealership's financials, farmers are refurbishing old tractors rather than investing in new tractors. This slowdown in capital investment will presumably hurt crop yields in the long term.

In sum, contrary to Tucker's video and many other "sanctions aren't working" videos on YouTube, the videos made by expatriate Canadian and Australian farmers suggest that the opposite: sanction are having an effect. And it isn't a good one.