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Ethereum's Compliance Landscape: A Transformational Shift

Martin Walker
Sep 29, 2023 at 11:24 am

The monumental and groundbreaking Merge upgrade, a defining moment in Ethereum's trajectory, took place in the illustrious month of September 2022. It was a transformative shift from the traditional proof-of-work (PoW) consensus mechanism to the more modern and environmentally friendly proof-of-stake (PoS) protocol. However, this transition brought about an interesting and notable consequence: a discernible decrease in the platform's adherence to the compliance standards stipulated by the esteemed Office of Foreign Assets Control (OFAC).

Transactions that failed to align with the stringent OFAC compliance were, unsurprisingly, subjected to restrictions within the Ethereum blocks. This introduced a nuanced challenge, affecting the very fabric of neutrality within the intricate Ethereum ecosystem. Notably, in the initial stages of the vibrant month of August 2022, OFAC imposed sanctions on Tornado Cash, a privacy-focused protocol, and several Ether (ETH) addresses associated with it. The grounds for these sanctions were primarily rooted in Tornado Cash's exceptional ability to obfuscate and anonymize transactions.

In the pre-Merge era, Ethereum's commitment to OFAC compliance witnessed an exponential surge. Various entities, including influential crypto exchanges, made the strategic choice to deploy censoring MEV-Boost relays on their validators. Among the culprits on the list of significant censorship offenders were prominent platforms like Binance, Celsius Network, Bitfinex, Ledger Live, and Huobi (HTX), along with the widely recognized Coinbase, as highlighted by the comprehensive MEV Watch data.

List of entities running censoring MEV relays on their validators are actively harming Ethereum’s credible neutrality. Source: MEV WatchList of entities running censoring MEV relays on their validators are actively harming Ethereum’s credible neutrality. Source: MEV Watch

However, as fate would have it, the overall OFAC compliance in Ethereum's blocks experienced a noticeable and rather pronounced decline. The decline was particularly conspicuous by the time November 2022 graced the calendar, with a mere 78% of the total Ethereum blocks adhering diligently to the stringent OFAC regulations. Fast forward to the present, specifically September 27, and the OFAC compliance for Ethereum has taken a nosedive, resting at a mere 30%. This staggering statistic signifies an overall reduction of a remarkable 57%, an undeniable and substantial shift.

Post-Merge daily OFAC-compliant Ethereum blocks. Source: MEV WatchPost-Merge daily OFAC-compliant Ethereum blocks. Source: MEV Watch

To navigate the complex landscape of OFAC compliance, operators and stakeholders are encouraged to opt for relays that operate without any form of censorship, aligning seamlessly with OFAC requirements. In this endeavor, seven major MEV-boost relays have emerged as popular choices, including the likes of Flashbots, BloXroute Max Profit, BloXroute Ethical, BloXroute Regulated, BlockNative, Manifold, and Eden. However, it is essential to note that not all these systems strictly adhere to OFAC compliance, as illuminated by insights from MEV Watch:

"Among the seven major relays available, a mere three refrain from censoring transactions in accordance with the rigorous OFAC compliance requirements."

This nuanced understanding emphasizes the intricate nature of the compliance landscape, hinting at the delicate balance operators need to strike between regulatory alignment and transaction transparency.

Intriguingly, it's important to underscore that not all blocks crafted by OFAC-compliant relays engage in censorship. However, the firm stance remains: any block created by an OFAC-compliant relay will inevitably transition into a state of censorship when faced with non-compliant transactions seeking entry into the expansive Ethereum network.

While the focal point of OFAC regulations predominantly targets organizations rooted in the vibrant landscape of the United States, it's worth noting that validators operating beyond these geographical boundaries also shoulder a significant responsibility. For the greater good of the network and to ensure an equitable and unbiased playing field, validators outside the U.S. should conscientiously consider running relays that embrace a non-censoring ethos, a choice driven by a global perspective.

In the midst of Ethereum's nuanced and evolving journey with OFAC compliance, Grayscale, a well-known entity in the crypto realm, made a pivotal and noteworthy decision. This decision saw Grayscale relinquishing all rights associated with PoW Ethereum tokens, often affectionately abbreviated as ETHPoW. However, the motivations behind this move were not just as simple as a strategic shift in protocol. Rather, it was a calculated response to the prevailing liquidity challenges witnessed in the market. In the eloquent words of their official announcement:

"As such, given the prevalent circumstances, the viable exercise of rights to acquire and sell the ETHPoW tokens is not within reach. Consequently, Grayscale has gracefully chosen to relinquish the rights to these valuable assets, a decision made on behalf of the esteemed record date shareholders."

Contrasting this decision, some distinguished cryptocurrency investment firms, such as the innovative ETC Group, boldly embarked on a journey to introduce specialized EthereumPoW exchange-traded products (ETPs). This move reflected their vision and determination to navigate the ever-evolving crypto landscape, embracing innovation with fervor and ambition.

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