As alternatives to the traditional financial system, cryptocurrencies find one of their most important qualities in resistance to censorship. However, that feature is increasingly compromised on one of the two busiest networks, Ethereum.

Censorship of transactions in a cryptocurrency network consists of certain operations not being included in the mined blocks that are recorded in the network's distributed ledger. It is usually applied to addresses suspected of illegal activities or those known to harbor funds from illegal activities.

And who determines which transactions should be censored? This is something that government agencies in various countries do. To apply the restrictions, they turn to companies that participate in the operation of networks such as Ethereum, which are registered in some country to offer their services, and therefore must comply with the laws of each jurisdiction.

Who Filters the Transactions?

Suppose the United States, Russia, Germany, or any other country decides that addresses that have traded cryptocurrencies on a given exchange cannot transact on Ethereum. How does a government make this happen?

In this specific context, the block creators or “validators” of the Ethereum network are the ones who can implement transaction filtering. Validators are participants who have the power to decide which transactions they will include in the transaction blocks they are creating and validating in order to obtain the reward and part of the commissions that they offer.

However, the decision to filter transactions may vary between different block creators. There are some that are more pressured than others, and they are those that use relays (transaction relays) with MEV-boost. MEV-boost is software used to order the transactions of a block in a way that maximizes commission earnings for miners. The main developers of MEV-boost are Flashbots, Ultra Sound Money and Bloxroute (which has a regulated version in the United States and an unregulated version).

Similarly, enterprise staking pools or centralized exchanges—which today largely dominate the market—may be required to comply with the regulations of the countries where they were registered, whether or not they use relays with MEV -boost. For the most part, Ethereum validator nodes are set up and controlled by staking pools at the time of writing this article. Therefore, pools have great decision-making power regarding transaction censorship.

If a Government Decides so, Are Transactions Filtered?

If a government or entity issues sanctions against a specific address, some Ethereum network participants may choose not to include transactions involving that address in the blocks being validated.

If a government or entity issues sanctions against a specific address, some Ethereum network participants may choose not to include transactions involving that address in the blocks being validated.

However, that does not imply that the transaction is completely excluded from Ethereum blocks. When it reaches a validator who is not obliged to filter it by national or international regulations, it can be added to a block. Of course, the higher the percentage of actors who censor transactions, the more difficult it will be to find that "window" for the transaction to pass.

Therein lies the importance of the decentralization so prominent in cryptocurrency networks. By introducing a centralized element in decision-making, governments gain influence over which transactions are acceptable. For decentralized finance (DeFi) and an accessible and inclusive monetary system to be possible, decentralization is a core value.

There are three staking pools in Ethereum that control half of the network's validators. Among them, Lido is the largest, currently applying censorship to 27% of the 69,000 MEV-boosted validators it controls. It is followed by Coinbase, which filters transactions in 17% of its 33,000 validators of this type, and Binance, which censors 12% of its 9,000 validators with MEV-boost.

What Does it Mean When OFAC Transactions are Not Executed?

When it is mentioned that OFAC transactions are not executed on Ethereum, this is referring to the selective censorship of transactions that are related to addresses or protocols sanctioned by the Office of Foreign Assets Control (OFAC) of the United States government.

OFAC is a government agency charged with enforcing economic and trade sanctions against individuals, entities or countries that are considered a threat to the national security of the United States. If an Ethereum address or an associated protocol is on the OFAC sanctions list, some entities involved in block creation may choose not to include transactions involving those addresses in the blocks they validate.

In the context of Ethereum, the validity of a transaction is primarily determined by its compliance with the protocol's rules. That is, they must have the correct format, the private signatures necessary for sending, sufficient balance and gas from the issuer, and comply with the consensus rules of Ethereum and the smart contract, if applicable.

Conversely, there are some situations in which transactions could be considered invalid under the criteria of OFAC or other regulators in the United States or other countries. It could occur in the following circumstances:

Involvement of sanctioned entities: if a transaction involves transfers of funds or assets to or from an entity or individual that is subject to sanctions from regulators, that transaction is likely to be considered as invalid or subject to restrictions.

Trade Embargo: Transactions that violate trade embargoes imposed by regulators could be considered invalid. For example, trading certain goods or services with embargoed countries or entities may be prohibited.

Financing of prohibited activities: if a transaction is intended to finance activities that are prohibited, such as terrorist activities or proliferation of nuclear weapons, it is likely to be considered invalid.

Use of Sanctioned Protocols: If the transaction involves the use of specific protocols or services that were sanctioned, it may be considered invalid. For example, addresses that interacted with the transaction mixer Tornado Cash were subject to restrictions in 2022.

It is important to note that these considerations go beyond the technical rules of the Ethereum network itself and are linked to the application of government policies and economic sanctions towards entities that participate in the operation of the network. OFAC-related transaction censorship implies that some participants in the Ethereum network are taking active steps to prevent the inclusion of certain transactions in the blocks they validate .