Could OFAC Sanctions Lead to Censorship on Ethereum?

Questions have been rising over possible censorship of Ethereum transactions.

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August 30, 2022

Censorship of Ethereum transactions in response to sanctions by the U.S. Treasury Department’s Office of Foreign Asset Control (OFAC) is a topic of intense debate in the crypto community. Recent concerns regarding sanctions of Tornado Cash, and a slew of Ethereum addresses associated with it, announced on August 8th by OFAC have reached a fever pitch.

Can Ethereum be Censored?

Questions have been raised over possible Ethereum censorship. Pseudonymous open protocols were supposed to be immune.

Concerns are rising over the prospect of censorship by entities that are domiciled within the U.S. jurisdiction. The OFAC sanctions have kept crypto stakeholders of all stripes closely watching whether Ethereum could be censored post-merge. Statistical data from Dune Analytics reveals that over 66% of ETH Beacon Chain validators could be compelled to comply with the regulation. Would large staking providers like Coinbase and Kraken abide by the sanctions? If so, how would the Ethereum community respond?

Lefteris Karapetsas posed the question to major stakers in a Twitter poll, which Coinbase CEO Brian Armstrong gamely responded to.

It's a hypothetical we hopefully won't actually face. But if we did we'd go with B i think. Got to focus on the bigger picture. There may be some better option (C) or a legal challenge as well that could help reach a better outcome.
— Brian Armstrong - barmstrong.eth (@brian_armstrong) August 17, 2022

Crypto luminary Eric Wall followed it up with an even more provocative poll.

Question for the Ethereum community. If a majority of stake chooses A in this poll, will you:

X) Consider the censorship an attack on Ethereum and burn their stake via social consensus
Y) Tolerate the censorship https://t.co/Mf48co37jK
— Erica Wall (X🏴, X🏴) (@ercwl) August 15, 2022

None other than Ethereum co-founder Vitalik Buterin revealed that he voted X in the poll and would consider the censorship as an attack on the blockchain and to burn the stake of staking providers who censored transactions of the addresses on OFAC’s Specially Designated Nationals (SDN) list.

Why Compliance With OFAC Sanctions Will Not Censor Ethereum

Crypto researcher Justin Bons, founder and CIO of Cyber Capital, posted a Twitter thread on AUG. 19, 2022, explaining more about the censorship issue and why it would difficult to pull off.

3/14) This is because it would only take one validator/miner to include such TXs for it to be included in the canonical chain

This means that a very small minority of validators/miners can counter such censorship over both ETH & BTC!

Easily less than 1% can prevent censorship!
— Justin Bons (@Justin_Bons) August 19, 2022

As Bons explains, OFAC-compliant stakers could ignore blocks containing OFAC-violating transactions. This would be a chain split. If major staking providers like Coinbase and Kraken split the chain in such a way, coins on the uncensored chain would be burnt through social consensus. If the censored chain subsequently failed, the staking providers would liable for the losses. Bons concludes that compliance with the sanctions is unlikely, even with stakers vulnerable to OFAC enforcement actions. The more likely path would be to shut down staking operations.