Dragonfly Venture Capital and Tornado Cash

Venture capital firm Dragonfly announced on Friday that the U.S. government is considering potential charges related to its 2020 investment in PepperSec, the developer of Tornado Cash. This marks a rare instance where federal prosecutors might target a venture investor for supporting a crypto project.

Dragonfly’s Response

In a detailed statement, managing partner Haseeb Qureshi described the prospect of charges as “outrageous” and legally unfounded. He stated that the firm invested in PepperSec in August 2020 after receiving an independent legal opinion confirming that Tornado Cash complied with federal guidance issued by the Financial Crimes Enforcement Network (FinCEN) in 2019.

Qureshi emphasized that Dragonfly is committed to supporting open-source privacy-preserving technologies and continues to stand by its investment.

Legal Background and Controversy

This development follows a recent setback in the trial of developer Roman Storm, where the FBI struggled to connect stolen funds from a key witness to Tornado Cash.

Launched in 2019, Tornado Cash is a decentralized protocol that mixes cryptocurrency transactions to obscure sender and recipient details. While it is valued by privacy advocates, U.S. authorities have accused it of facilitating money laundering for hacking groups, including North Korea’s Lazarus Group.

In 2022, the Treasury Department’s Office of Foreign Assets Control (OFAC) sanctioned Tornado Cash, but court challenges led the government to roll back certain sanctions, which Dragonfly cited as evidence of the protocol’s legal standing.

Qureshi noted that Dragonfly did not operate Tornado Cash nor had any contact with illicit users, stressing that the firm provided PepperSec with the same guidance it offers all portfolio companies. He also mentioned that Dragonfly fully complied with a Department of Justice subpoena in 2023 and was informed it is not a direct target of the ongoing investigation.

Implications for the Crypto Industry

According to Qureshi, the government’s reference to Dragonfly in a recent court proceeding seems aimed at undermining Tornado Cash’s defense, potentially complicating testimony from Dragonfly co-founder Tom Schmidt. He argued that prosecuting an investor for the actions of a portfolio company, years after the fact, would discourage venture funding for privacy technologies and blockchain innovation.

Dragonfly’s statement comes amid increased enforcement actions against crypto privacy tools, viewed by regulators as a growing risk for illicit finance. The firm remains confident that the DOJ will not pursue charges but pledged to “vigorously defend” itself if necessary.