Tools are innocent, but are investors guilty? Currently, it is reported that the U.S. Department of Justice is evaluating whether to file criminal charges against Tom Schmidt and others, partners of the venture capital firm Dragonfly Capital. The reason is their investment in the privacy mixing protocol Tornado Cash in 2020, which could become the first case of a VC being prosecuted for an invested project.
From Witness to Defendant
The case broke out when Tornado Cash developer Roman Storm was on trial in Manhattan. Storm is charged with conspiracy to launder money, operating an unlicensed money transfer business, and violating financial sanctions, with a maximum sentence of 45 years.
The defense team originally wanted to call investor Tom Schmidt as a witness, but the prosecution refused to grant him immunity (potentially turning him into a defendant), forcing Schmidt to invoke the Fifth Amendment (choosing not to answer questions in court because the answers might incriminate himself).
Judge Katherine Polk Failla inquired in court whether the prosecution was considering expanding the scope of the indictment, with the prosecution only revealing that they are focusing on Tom Schmidt and another individual, and requesting the records be sealed.
After the news spread, Dragonfly managing partner Haseeb Qureshi posted on the X platform to clear the company's name, emphasizing that they did not participate in Tornado Cash's operations, did not contact malicious users, and have been cooperating with government investigations since 2023. Qureshi directly stated that if the U.S. Department of Justice targets investment activities, it will create a "chilling effect" on the U.S. crypto industry.
We defend privacy while cooperating with investigations. If investors face criminal liability for invested projects, the market will pay a high price.
Is "Limited Liability" Still Without Legal Risk?
Internal communications presented by the prosecution show that Schmidt and Qureshi discussed establishing a KYC mechanism for Tornado Cash. The prosecution is trying to prove that Dragonfly was not merely a fund provider but bears responsibility for aiding or abetting.
Traditionally, VCs and general partners enjoy limited liability protection, only facing legal responsibility in cases of gross negligence or intentional illegal participation. An analysis by Columbia Law School also points out that regulators usually must prove that investors had actual knowledge or intentionally ignored wrongdoing.
If the U.S. Department of Justice successfully breaks through this defense, venture capital firms will be forced to strengthen due diligence, especially for startups focusing on privacy or decentralization. Internal compliance costs within companies will inevitably rise, and the pace of startup investments across the U.S. may be forced to slow down.
If Dragonfly is found guilty, funds might withdraw from high-risk, privacy-oriented projects and shift towards more compliant blockchain applications. DeFi and other experimental models may be affected, and the U.S.'s global crypto innovation competitiveness will be tested. For the venture capital world, investment agreements may need to include more protective clauses, with legal advisors intervening early in "technical details".
