From Sanctions to Legal Trials: The Debate on Privacy and Responsibility of Tornado Cash

The year 2025 will be a watershed moment for the development of stablecoins, as the global regulatory framework accelerates its implementation and continues to improve, with the former "gray areas" being clearly classified under regulatory guidelines. This market, valued at over $250 billion, is undergoing the growing pains and transformation from reckless expansion to Compliance. The core definition, classification, and importance of stablecoins (1) Core Definition of Stablecoin Stablecoin is a special type of cryptocurrency, with the core goal of maintaining value stability (as opposed to cryptocurrencies like Bitcoin and Ethereum that seek price appreciation). It achieves value anchoring through pegging or reliance on fiat currencies, commodities, or other crypto assets, providing a value benchmark for the highly volatile digital asset market. Stablecoins essentially serve as a "bridge asset" connecting the traditional financial world with the crypto digital world. They inherit the technological advantages of cryptocurrencies (such as globality, 24/7 operation, programmability, and peer-to-peer transmission), while also possessing the value stability of traditional fiat currency, currently supporting trillions of dollars in funds circulating within the crypto ecosystem each month. (2) Types of stablecoins According to different anchoring mechanisms, stablecoins are mainly divided into three categories:

1. Fiat-collateralized stablecoins: pegged 1:1 to fiat currencies (such as USD), with reserve assets mostly consisting of cash, short-term government bonds, and other low-risk assets. Typical representatives are USDT (issued by Tether) and USDC (issued by Circle). The core risk lies in the authenticity and transparency of the reserve assets.
2. Cryptocurrency collateralized stablecoins: These are over-collateralized with other crypto assets (collateralization ratio usually exceeds 150%), and maintain stability through smart contracts that automatically adjust the collateral ratio. A typical representative is DAI (issued by MakerDAO), with the core risk being the liquidation risk triggered by a sharp decline in the price of the collateral assets.
3. Algorithmic stablecoin: No physical collateral, relies on algorithms to adjust supply and demand (such as minting new coins - destroying old coins mechanism) to maintain price, a typical case being the UST that crashed in 2022. The core risk lies in the "death spiral" that occurs when the algorithmic mechanism fails (a vicious cycle: price decline leads to panic, panic triggers sell-offs, sell-offs further lead to price declines, until the system collapses). (3) The Importance of Stablecoins The importance of stablecoins is specifically reflected in the following four core functions:
4. The most original and fundamental functions of stablecoins are as a "medium of exchange," "measure of value," and "safe haven" in the cryptocurrency ecosystem. In cryptocurrency trading, the vast majority of trading pairs (such as BTC/USDT, ETH/USDC) are priced in stablecoins rather than the highly volatile Bitcoin or Ethereum. This provides investors with a clear measure of value, avoiding the confusion of measuring a volatile asset with another volatile asset. When the market experiences severe volatility or uncertainty, traders can quickly exchange their holdings of high-risk assets like Bitcoin and Ethereum into stablecoins (such as USDT and USDC) to hedge against risks, lock in profits, or temporarily exit without having to completely withdraw funds from the crypto ecosystem (exchanging back to fiat currency is usually time-consuming and costly). This greatly enhances capital efficiency and market liquidity.
5. Stablecoins demonstrate low cost, fast speed, and strong financial inclusion characteristics in global payments and remittances. Stablecoins leverage blockchain technology to bring revolutionary changes to cross-border payments and remittances. Compared to traditional bank wire transfers (which may take several days and incur high fees), stablecoin transfers can be completed in just a few minutes with very low fees, unrestricted by business days and time zones. In addition, stablecoins provide access to the global financial system for billions of people without bank accounts but who can go online; all they need is a digital wallet to receive and hold value-stable assets.
6. Stablecoins are the lifeblood of decentralized finance (DeFi) Without stablecoins, the prosperity and development of DeFi would be unimaginable. Almost all lending, trading, and derivatives protocols use stablecoins as the underlying asset. For example, in lending protocols like Aave and Compound, users deposit large amounts of stablecoins such as USDC and DAI to earn yields, or borrow stablecoins for other investment operations, with the interest rate market largely built around stablecoins. In MakerDAO, the DAI stablecoin is the core output of the entire protocol, where users generate DAI by over-collateralizing other crypto assets, thus converting volatile assets into stable assets. In decentralized exchanges (DEX) like Uniswap and Curve, stablecoin trading pairs (like USDT/USDC) often see daily trading volumes exceeding $1 billion, forming the basis of all trading activities.
7. Stablecoins are the "catalysts" for the digital transformation of traditional finance (TradFi) The preferred tool for traditional financial institutions and large enterprises exploring blockchain applications is stablecoin. Stablecoins are the least risky and most familiar entry point for them into the crypto market. Currently, in the most promising direction of RWA (Real World Asset tokenization), stablecoins serve as the core settlement tool, driving the "tokenization" of traditional assets such as stocks, government bonds, and corporate bonds, and enabling their trading on the blockchain, creating new investment opportunities. When talking about stablecoins, compliance must be mentioned. In May 2022, the algorithmic stablecoin UST and its sister token Luna spiraled into a collapse within days, resulting in an instant evaporation of over $40 billion in market value. This disaster is not an isolated case; it is like a giant stone thrown into the lake of cryptocurrency, whose ripples profoundly reveal the fractures beneath the facade of stablecoin prosperity: it exposes the fatal flaws of the algorithmic mechanism, raises questions in the market about the adequacy of stablecoin reserve assets, and alerts global regulatory agencies with the highest warning. Stablecoins are far more than just a "non-volatile cryptocurrency." They are the infrastructure of the crypto economy, a new paradigm for global payments, and a strategic bridge connecting two parallel financial worlds. Their significance makes their Compliance, transparency, and robust operation not just an industry issue, but a global topic that relates to the stability of the entire financial system, which is the fundamental reason why global regulatory agencies are now placing such high importance on them. The scale of major stablecoins (such as USDT and USDC, accounting for over 85% of the global market) and their intertwining with the traditional financial system have reached a level of "systemic importance," with risks that could be transmitted to traditional finance, approaching the critical point of "Too Big to Fail." This determines that Compliance is not an "option," but rather a "prerequisite for survival," for three core reasons as follows:
8. Preventing the transmission of systemic risks The collapse of a major stablecoin (such as USDT) will no longer be confined to the cryptocurrency market. Due to its holdings by numerous traditional hedge funds, publicly listed companies, and payment companies, its failure would trigger massive liquidations in on-chain DeFi protocols like a domino effect, rapidly spreading to traditional financial markets such as stocks and bonds through institutional investors, potentially triggering a global liquidity crisis. Compliance with reserve asset audits and redemption guarantees is the first line of defense to prevent this domino from falling.
9. Block illegal financial activities The global nature, quasi-anonymity (on-chain addresses can be traced, but user identities are not directly linked), and peer-to-peer transmission characteristics of stablecoins make them highly susceptible to use in money laundering, terrorist financing, and evading sanctions. In 2023, the global scale of illegal transactions involving stablecoins reached $12 billion, with over 60% flowing to regions under cross-border sanctions. Without strict Compliance requirements for KYC (Know Your Customer), KYT (Know Your Transaction), and sanctions screening, this efficient financial highway will become a perfect tool for criminals, triggering severe regulatory crackdowns by sovereign nations.
10. Maintain currency sovereignty and financial stability The widespread use of dollar stablecoins in emerging markets (such as over 20% of cross-border trade in Argentina and Turkey settled in USDT) effectively executes a form of "shadow dollarization" when privately issued dollar stablecoins are widely adopted in overseas markets. This occurs when citizens in a country spontaneously use dollars to replace their unstable national currency for savings and transactions, which erodes the monetary sovereignty and effectiveness of monetary policy in other countries. For the United States itself, the potential risk of runs on unregulated stablecoins being widely used for payments may threaten domestic financial stability. Therefore, Compliance is no longer an option for the industry, but an inevitable requirement to maintain national financial security. When discussing stablecoins, compliance must be mentioned, as its "infrastructure" attributes determine that it can no longer enjoy the "gray area" dividends of early cryptocurrencies. Compliance is no longer a shackle that hinders its development but rather a license for entry and a trust anchor for whether it can be accepted by the mainstream financial system and whether it can survive sustainably. The global wave of regulation is not intended to stifle innovation but to attempt to rein in this runaway wild horse before it's too late, guiding it toward a transparent, robust, and responsible future. The main compliance risks faced by stablecoins (1) Legal Qualitative Risk - Regulatory recognition differences lead to a surge in Compliance costs. Different jurisdictions have varying definitions of stablecoins:
11. U.S. regulators are still debating whether stablecoins should be classified as securities, commodities, or payment transmission tools. For example: the SEC (U.S. Securities and Exchange Commission) tends to classify asset-backed stablecoins issued based on specific projects as securities, the CFTC (U.S. Commodity Futures Trading Commission) believes they may fall under commodities, and the OCC (Office of the Comptroller of the Currency) allows banks to issue "payment stablecoins". This overlapping regulation requires issuers to comply with multiple sets of compliance requirements.
12. The EU MiCA regulation classifies stablecoins into "electronic money tokens" (which are pegged to a single fiat currency, such as USDC) and "asset-referenced tokens" (which are pegged to multiple types of assets). The former must meet electronic money regulatory requirements, while the latter must also submit a risk reserve scheme.
13. The Hong Kong "Stablecoin Regulation" views stablecoins as a payment tool that requires strict regulation (focusing on stablecoins as a store of value and means of payment), rather than securities or other types of assets. This kind of qualitative uncertainty, along with the possibility that regulatory agencies (such as the SEC and CFTC in the United States, or EU regulators) may suddenly introduce a set of strict new regulations and deem existing models non-compliant, will lead to significant compliance complexities and costs for stablecoin issuance. (2) Reserve Asset Risk - Lack of Transparency Can Trigger a Run on the Bank The authenticity, adequacy, and transparency of reserve assets are the core challenges faced by stablecoins, and the industry currently faces three major issues:
14. Insufficient reserve assets. In 2019, it was revealed that Tether (USDT) was only 74% backed by real assets, despite the company's long-standing claims of being fully collateralized. As of Q3 2024, Tether disclosed that over 60% of its reserves consist of short-term government bonds, but it is still questioned due to the frequency of audits (once per quarter) being lower than that of USDC (once per month). As of now, Tether has also switched to releasing its reserve reports at least monthly, and typically provides daily updated reserve data.
15. Non-compliance of assets. Some small stablecoins allocate their reserve assets to high-risk areas (such as stocks and crypto assets), and in 2023, a certain stablecoin experienced a 30% drop in reserve assets, triggering a decoupling.
16. Insufficient disclosure. Only 30% of stablecoin issuers publicly disclose the specific custodial institutions and details of reserve assets (2024 Crypto Industry Report), making it difficult for investors to verify the authenticity of the assets. According to the U.S. GENIUS Act, Hong Kong's Stablecoin Ordinance, and other new regulations, reserve assets must be 100% cash, short-term government bonds, and other highly liquid assets, and must be audited daily. Issuers must meet strict capital, liquidity, and disclosure requirements. The lack of transparency or insufficient reserve assets can directly trigger a run on the assets, leading to a depegging. The issuer will face hefty fines from regulatory authorities, operating suspension orders, or even criminal charges. (3) Anti-Money Laundering and Counter-Terrorism Financing (AML/CFT) Risks - A Major Area of Regulatory Penalties Anti-Money Laundering (AML) and Counter-Terrorism Financing (CFT) are key regulatory concerns. The price stability and global accessibility of stablecoins make them an attractive tool for money laundering and sanction avoidance. Unlike volatile cryptocurrencies, stablecoins allow bad actors to maintain asset value while transferring funds. Regulators now require strict KYC (Know Your Customer), KYT (Know Your Transaction), and reporting of suspicious transactions (suspicious behaviors such as frequent small transfers aggregation, large cross-border transfers, etc.) procedures. Violating AML/CFT regulations will incur the most severe penalties and seriously damage reputation. (4) Market Integrity Risk - Weaknesses in Investor Protection The stablecoin market has two core integrity risks that directly harm investors' rights: market manipulation and false statements. Large amounts of stablecoins may be used to manipulate the prices of Bitcoin or other crypto assets. False advertising or insufficient information disclosure regarding reserve assets and algorithmic mechanisms can also mislead investors. Regulatory requirements are now more stringent, aimed at ensuring that investors do not suffer losses due to insufficient information. (5) Systemic Risk - Potential Threats to Financial Stability Systemic risk is the issue that financial authorities are most concerned about. DeFi protocols hold billions in stablecoins, and even if a major issuer encounters problems, it could trigger a series of liquidations throughout the entire ecosystem. Imagine a domino effect: a major stablecoin collapses, lending protocols that use it as collateral begin to fail, and users who staked their coins suffer severe losses. Soon, the shockwaves will spread to traditional financial institutions that have already started integrating cryptocurrency technology, and this chain reaction could be devastating. (6) Sanctions Compliance Risk - Challenges of Global Operations The issuance of stablecoins faces compliance requirements for sanctions from multiple countries and regions, with core challenges including:
17. Differences in sanctions lists. There are overlaps but not complete consistency among the sanctions lists of OFAC (Office of Foreign Assets Control of the U.S. Treasury), the European Council, and the United Nations Security Council. For example, a certain entity may be sanctioned by OFAC but not by the EU, so targeted screening rules need to be established.
18. On-chain address screening. Smart contract addresses may also be included on sanctions lists. For example: "Some issuers use on-chain address blacklist systems (such as Circle's USDC freezing assets of OFAC sanctioned addresses), and smart contracts incorporate sanction screening modules to prevent stablecoins from flowing into sanctioned addresses, achieving real-time Compliance.
19. Decentralization Contradiction. Some decentralized stablecoins find it difficult to enforce freezing of sanctioned address assets, facing the challenge of balancing Compliance and decentralization. The complexity of global Compliance requires meeting the different sanction lists and requirements of multiple countries simultaneously. Stablecoin issuers must find a balance between technological innovation and Compliance obligations, which also means increased operational costs and compliance difficulties. (7) Cross-Border and Jurisdictional Risks - The End of Regulatory Arbitrage Regulatory arbitrage (the practice of taking advantage of differences and gaps in regulatory rules between different countries or regions, choosing to conduct business in places with the least strict regulation and lowest costs to avoid stringent oversight) is a real issue in the stablecoin market. Project parties may choose to register in regions with loose regulations, but their users are spread across the globe. This has created a "hellish" compliance dilemma: the need to comply with the different laws of hundreds of jurisdictions simultaneously, which is extremely difficult to operate. The inconsistency and even conflicts of regulatory policies in different countries leave the issuers at a loss. Global Regulatory Trends Major jurisdictions around the world are actively taking action to incorporate stablecoins into their regulatory frameworks: (1) U.S. Regulatory Framework The United States has adopted a multi-agency regulatory framework (SEC, CFTC, OCC, Treasury), and the "GENIUS Act" allows non-bank entities (NBEs) and subsidiary institutions of insured deposit institutions (IDIs) to act as issuers. The Act emphasizes the redemption process, requiring issuers to establish clear redemption policies and procedures to ensure that stablecoin holders can redeem in a timely manner. However, the Act does not mandate that stablecoins maintain par value in the secondary market, where most trading occurs. (2) The EU's MiCA framework The EU's Markets in Crypto-Assets Regulation (MiCA) establishes a comprehensive and stringent regulatory framework for stablecoins, including licensing requirements, reserve asset requirements, and holder rights. MiCA divides stablecoins into two categories: "electronic money tokens" and "asset-referenced tokens," and implements different regulatory requirements for both, aiming to ensure that regulation is commensurate with the level of risk. (3) China's dual regulation China has adopted a unique dual regulatory approach to stablecoins: the issuance and trading of stablecoins are strictly prohibited on the mainland, while a comprehensive regulatory system is implemented in Hong Kong. The Hong Kong "Stablecoin Regulations" will be officially implemented in August 2025, requiring 100% reserve asset segregation, with reserve assets needing to be high liquidity assets such as cash, US dollars, or Hong Kong dollar government bonds. The Hong Kong Securities and Futures Commission also requires custody by licensed banks in Hong Kong, daily audits, and assurance of the ability to redeem the next day. This prudent regulatory approach aims to make Hong Kong a global innovation hub for digital assets. (4) Trends in International Organization Regulation - Promoting Global Unified Regulatory Standards The Financial Stability Board (FSB) and the Bank for International Settlements (BIS) are developing globally unified regulatory recommendations for stablecoins, aimed at preventing regulatory arbitrage and ensuring global financial stability. In July 2023, the FSB released the "Global Regulatory Framework for Crypto Asset Activities," requiring stablecoin issuers to meet four core requirements: "adequacy of reserve assets, transparency of redemption mechanisms, anti-money laundering Compliance, and systemic risk prevention." The Basel Committee on Banking Supervision (BCBS) has revised the "Prudential Treatment of Crypto Asset Exposures" standards in 2024, which will officially take effect on January 1, 2025. It proposes a stricter and more prudent global unified framework for the risk management of banks holding crypto assets (including stablecoins), aimed at addressing the risks posed by crypto assets while maintaining financial stability. Compliance Path: A Guide for Issuers and Investors' Actions (1) Issuer: Build a comprehensive Compliance system The issuance of stablecoins faces multidimensional challenges and requires the construction of a comprehensive Compliance system from four dimensions: embracing regulation, reserve asset management, technical compliance, and risk prevention.
20. Actively embrace regulation. Prioritize applying for licenses in regions with clear regulations (such as the United States, European Union, Hong Kong), and regularly communicate with regulatory agencies to avoid compliance raids.
21. Standardize the management of reserve assets. Strictly allocate reserve assets according to regulatory requirements (such as 100% cash + short-term government bonds), select leading custodians (such as HSBC Hong Kong), and have qualified accounting firms regularly issue audit reports on reserve assets, publicly disclose the details of reserve assets (including custodian account information and asset type proportions).
22. Strengthen the technical compliance system. Invest resources to build a top-notch AML/KYC and sanctions screening system, for example: leading issuers often adopt a combined model of "on-chain transaction tracking + offline identity verification" (such as USDC requiring large users to complete facial recognition + address tracing). At the same time, integrate third-party compliance tools like Chainalysis to achieve KYT screening for cross-chain transactions. In terms of cybersecurity risks, it is necessary to prevent network attacks that could lead to asset theft, private key loss, blockchain network failures, smart contract code vulnerabilities, network forks, etc.
23. Improve risk control. Regularly conduct stress tests (e.g., simulate a scenario where 10% of users concentrate on redemptions), ensuring that the liquidity of reserve assets can cover 100% of redemption demand within 30 days, establish a risk reserve fund (not less than 2% of the issuance scale), to deal with unexpected de-pegging risks, and formulate emergency plans (e.g., a limited redemption mechanism when reserve assets are insufficient). (2) Investors: Establish a risk screening framework Investors should conduct comprehensive due diligence and gain a deep understanding of the issuer's qualifications, license, reserve asset composition, audit history, and compliance status before researching any stablecoin project. Preferring compliant assets is key to reducing risk, and investors should prioritize stablecoins like USDC, which are backed by high-liquid assets and are more transparent, rather than those projects that lack transparency. Most importantly, investors must recognize the risks and understand that "stability" is relative and not risk-free. Even fully collateralized stablecoins face counterparty risk, regulatory risk, and technological risk. Future Outlook: The Development Trends and Challenges of Stablecoins (1) The Development Trend of Stablecoins Global regulation is reshaping the landscape of stablecoins, but the true anchor of stability comes not only from legal compliance but also from technological transparency and market confidence. Stablecoins driven by compliance will exhibit the following trends:
24. The industry is becoming increasingly differentiated, and Compliance has become a core competitive advantage. For stablecoin projects, compliance is no longer optional, but a reflection of core competitiveness. Projects that can proactively embrace regulation, achieve extreme transparency, and build a strong compliance system (such as Circle, the issuer of USDC) will gain institutional trust and market share. On the contrary, those projects that attempt to linger in the gray area, with opaque reserves and ambiguous compliance, will continue to face regulatory scrutiny and sudden risks, and their survival space will be increasingly squeezed. The wave of global regulation is pushing stablecoins from the "Wild West" era into a new stage that is institutionalized, transparent, and highly compliant.
25. Regulatory trends are moving towards a unified global regulatory standard. There are still critical gaps in global stablecoin regulation, but core standards are unified globally. Regardless of regional differences, the three major requirements of reserve asset adequacy (100% highly liquid assets collateralized), transparency of redemption mechanisms (clear T+1 or T+0 redemption processes), and full AML/CFT compliance (KYC/KYT covering all users) have become common standards for global regulation. For example: although there are differences in licensing application processes and penalty standards in the U.S. "GENIUS Act", the EU's Mica, and Hong Kong's "Stablecoin Ordinance", all strictly require these three points to avoid regulatory arbitrage by issuers taking advantage of regional policy loopholes.
26. The application scenarios of stablecoins extend to the real economy. With the acceleration of the tokenization (RWA) of traditional real-world assets such as stocks, bonds, and real estate, stablecoins will become the preferred settlement tool for RWA transactions due to their value stability and compliance transparency. As a tool for cross-border payments, stablecoins have achieved cost reduction and efficiency improvement. Currently, emerging markets such as Southeast Asia and Latin America have become the core scenarios for stablecoin cross-border payments, and in the future, they will extend to areas such as cross-border trade for enterprises, supply chain finance, and wage distribution.
27. Conservative Asset Reserve Regulatory requirements state that reserve assets must be cash, high-quality liquid assets such as short-term government bonds, etc. This will force issuers to abandon high-risk investment strategies and shift towards more transparent and safer models. (2) Challenges of Stablecoins Despite the favorable pattern, stablecoins driven by Compliance still face huge challenges:
28. The redemption mechanism connection is missing. Currently, most regulations focus on primary market redemptions (direct redemptions by the issuer), but the stability mechanism in the secondary market (exchange market) is still lacking, and clear response rules for depegging in the secondary market need to be established.
29. The technical standards are not unified. The standards for smart contract security, cross-chain transaction compliance, and data privacy protection have not yet been globally unified, which may lead to technical compliance barriers.
30. Challenges to Financial Sovereignty. Large-scale stablecoins may affect the effectiveness of national monetary policy transmission and financial sovereignty. If stablecoins are deeply linked to the main financial system, their failure could trigger broader financial turmoil. Conclusion The future is here; compliance is no longer an option but the cornerstone of survival. Whether it is the issuer or the investor, only by actively embracing regulation, strengthening risk control, and enhancing transparency can one remain invincible in this transformation. The ultimate goal of stablecoins has never been to replace fiat currency, but to become a stable and efficient light in the financial infrastructure of the digital age. This road is destined to be long and full of challenges, but it is precisely these challenges that drive stablecoins towards a more mature, inclusive, and sustainable future. What we are witnessing is not just an evolution of technology, but an evolution of financial civilization.

Original Author: Lawyer Jie Hui