The Legal Implications of Maintaining Ethereum’s Censorship Resistance

Ethereum’s Extra-National Trump Card Against Sanctions

Article by Teresa Edited by Kornekt Cover Art by Pub-gmn.eth

Censorship resistance is at the core of Ethereum’s promoted values. Many questions have come up on this subject, especially after the U.S. Treasury Office of Foreign Assets Control (OFAC) sanctions against Tornado Cash. The circumstances that could make Ethereum censored and the extent to which nation-states could negatively impact the protocol is therefore worth considering.

The sanctioning of not just countries, individuals, and entities, but computer code is without precedent; it births several significant issues from a legal perspective.

With the Merge, there are now ways to prevent and recover from strong censorship at the base layer. Once other additions (currently in the research phase) such as Proposer/Builder separation are implemented, Ethereum will be even more resilient to any sort of censorship.

Weak vs. Strong Censorship

Weak censorship is when a transaction is being delayed because it wasn’t accepted by the validator in charge. This sort of censorship does not refer to an actual attack within the protocol and can be easily solved by automatically sending the transaction to a new validator.

For example, if Lido  —  a staking protocol that holds approximately 30% of staked ETH  —  was coerced by any jurisdiction to refuse validation for certain transactions, those transactions would probably be delayed in their execution but not completely stopped. Another validator would validate them. Besides, not all of Lido’s validators are in the same geographic location. In addition, Lido is governed as a DAO, which can be thought of as a network state that can make its own decisions on how to react to sanctions.

Strong censorship, in contrast, means a transaction is never included on the chain. This could happen if 51% or more of the validator nodes take control of the network and refuse to permit the transactions to be validated. There are different mechanisms to prevent and recover from a 51% attack. One of the preventive measures is to ensure jurisdictional diversity among the validators, such that not more than 51% of the validators are in the same legal jurisdiction.

With Ethereum’s transition to Proof-of-Stake (PoS), becoming a validator is easier and cheaper than being a miner in the former Proof-of-Work (PoW) system. At the moment, over 46% of Ethereum nodes are in the United States, Germany comes in second with 12%. Strong censorship could occur if one nation-state represents more than 51% of the validators or if one party buys more than half of the network stake.

As for recovery from strong censorship, the measure established by Ethereum is forking away from the censored chain, basically censoring the censor. In such a case, the Ethereum community would have to accept the new chain and continue building on top of it.

The Parties Involved in Ethereum Proof-of-Stake

Validators are the core component of Ethereum’s PoS. To become a validator, interested parties must deposit 32 ETH into the staking contract. Validators could be solo home stakers (these may be the ideal validators), a provider of staking as a service, a pooled staking arrangement, or a centralized exchange. Each of these options has different rewards, risks, and requirements.

The way PoS works is that one validator is randomly selected to be a block proposer in every slot. This validator is responsible for creating a new block and sending it out to other nodes on the network. For every slot, a committee of validators is randomly chosen, and their votes are used to determine the validity of the block being proposed.

Liability for Non-Compliance With Government Directives

When OFAC required parties to block interactions with Tornado Cash addresses, many complied with these requirements to avoid being liable for any violations. While much has been said about the topic, it is still a gray area; investigators in the matter say that base-layer participants do not have to monitor or censor the addresses. They argue that blockchain technology infrastructures aren’t required to comply based on current legislations (referring to the U.S. laws) because they are not financial institutions  —  independent participants are only publicly recording the order of data blocks at the infrastructure layer. 

In addition, requiring compliance would threaten the viability of the ecosystem and harm national security interests by pushing the technology development offshore. This sanctioning of not just countries, individuals, and entities, but also computer code is without precedent; it births several significant issues from a legal perspective.

The question also remains as to whether participants in the Ethereum network are ultimately responsible for the transactions validated within their blocks. If we talk about parties in the Ethereum community that are not in the base layer, it may be easier to determine responsibilities. Such parties, including centralized cryptocurrency exchanges, are likely to comply with regulations from the country they are based in, and could be prohibited from interacting with certain parties or executing certain transactions. However, this may not apply in other cases; for instance, once a smart contract is implemented on Ethereum, even the person who deployed it has no control over it.

Could the Ethereum network be held responsible if it processes transactions from sanctioned addresses? The problem is that no individual controls the network. Because of its decentralization, open-source nature and use, Ethereum is an extra-national entity that provides base layer neutrality. Ethereum is no one’s property, so how can it be sanctioned?

Actions From the Community

‘Activist Unstaking’ is a solution the Ethereum community has been proposing in the event of regulatory issues arising from the Tornado Cash sanctions. This would mean that, in order to protect the chain, validators would unstake before allowing censorship. For example, Coinbase’s CEO has indicated he may exit the staking business if he were forced to censor transactions. In fact, Coinbase is helping sue OFAC over the Tornado Cash sanctions by paying for six individuals to file a lawsuit (including two Coinbase employees).

Clearly, the crypto legal community has its work cut out for it. Continuous advocacy will be key in convincing nation-states and regulators to accept Ethereum as it is and ensure that possible regulations appropriately reflect the peculiarities of blockchain technology.

A version of this article initially appeared in BanklessDAO’s Decentralized Law newsletter on October 1, 2022.

Author Bio

Teresa has a background in litigation but now focuses on corporate preventive law. She is fascinated by lawyering in web3 and is licensed to practice law in Panama and Mexico.

Editor Bio

Kornekt is a writer and editor with strong conviction in the world Web3 creates.

Designer Bio

Pub-gmn.eth is a blockend developer.

BanklessDAO is an education and media engine dedicated to helping individuals achieve financial independence.

This post does not contain financial advice, only educational information. By reading this article, you agree and affirm the above, as well as that you are not being solicited to make a financial decision, and that you in no way are receiving any fiduciary projection, promise, or tacit inference of your ability to achieve financial gains.

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