Best Way to Explain How Can Cryptocurrencies Be Frozen on a Blockchain?
Can Cryptocurrencies Be Frozen on a Blockchain? The phrase “not your keys, not your crypto” is well-known in the cryptocurrency field, and many cryptocurrency users and investors rely on it when entrusting their holdings to others.
It is often assumed that if you possess your private keys, you will always have control over your assets and so will not be vulnerable to censorship. However, recent events have demonstrated that this is not always the case.
Indeed, you may be astonished to learn that freezing funds housed in an external wallet is not only theoretically possible, but also relatively prevalent. However, unless you’re involved in big criminal activities, the chances of it happening to you are slim.
Regardless, it is prudent to become acquainted with this relatively unknown occurrence.In this article, we debunk the notion that cryptocurrencies cannot be frozen on-chain.
How Does Freezing Funds on Blockchain Work?
Before we get into how developers might freeze assets within a wallet, a little tutorial on tokens is in order.
ERC-20 tokens, contrary to how they may appear when interacting with them, are essentially a reference to a database that maintains track of which addresses possess what amount of units of said token. The token contract is in charge of maintaining this database. When tokens are transferred from one person to another, the contract is in charge of adjusting the number of tokens connected with each address — subtracting the sum from one address and adding it to another to ensure the supply remains constant.
Because this is typically the sole smart contract with the authority to edit the token holder database,
It can be used to restrict access to funds, confiscate tokens, or even completely burn tokens in some situations.
If a smart contract blacklists an address, it may be unable to buy (or receive) and sell (or transmit) the token. Only an admin address will be able to use a blacklisted address to update the smart contract.
Why Does a Funds Freeze Happen?
As you might expect, these capabilities can be utilized to thwart attacks and confiscate illicit funds, or they might be abused if someone acquires admin control of a smart contract.
Though uncommon, the great majority of blacklisting events occur after an illicit behavior in the smart contract is found, such as when an attacker leverages an inflation bug to mint and transfer tokens to an address they control, or when the police request that assets be frozen pending investigation.
Tether (USDT) is one such coin that possesses these features. The USDT smart contract can be used to freeze and reissue USDT.
According to Bloxy explorer, the Tether token contract has banned 704 smart contracts in the previous month, with fresh addresses blacklisted every few days. Tether, for example, froze more than $150 million held across three addresses in January, claiming only that the money were frozen in response to a law enforcement request.
The Acala team recently locked 16 wallets containing nearly 3 billion aUSD – a multi-collateral stablecoin tethered to the US dollar. Following an issue that allowed aUSD liquidity providers to mint non-collateralized aUSD, the Acala team recovered and burned these illegally minted tokens, but not before the attackers dumped a significant amount on Polkadot-based DEXes.
Not just Ethereum-based token contracts may have freeze, blacklist, and confiscation capabilities. This functionality is embedded into most layer-1 blockchains as a key component of token contracts. This includes XRP and Stellar, which both allow developers to create tokens with a global freeze mechanism, allowing the issuer to halt token transfers.
However, this power to freeze often only applies to tokens. Contrary to popular assumption, freezing the native asset associated with most blockchains, such as BTC, ETH, BNB, or XRP, is not possible unless they are kept on a centralized platform, such as an exchange or with a custodian.
In general, the businesses behind these centralized companies will not freeze cash unless they are served with police or court documents.However, the connected parent business, issuer, or administrator may reserve the right to freeze the assets for any reason.
Address Blacklisting and Honeypot Scams
Though the blacklist feature can be utilized to isolate funds associated with suspected criminal activity, it can also be abused by scammers via so-called “honeypot scams.” Most commonly, this manifests itself in the form of tokens that cannot be sold after being purchased on a decentralized exchange.
Scammers can inflate the perceived value of their token on DEX explorers by exploiting the blacklist feature to automatically block outbound transfers for any address holding the token.
This results in a distinctive chart pattern, with wave after wave of consecutive green candles with few to no sell orders in between.
The fraudster, who owns the only whitelisted address(es), seeds the fraudulent token’s liquidity pool and waits for their LP tokens to appreciate in value as victims acquire the unsellable token.
When the community realizes the scam and purchases cease, the scammer(s) withdraw their LP tokens, claiming all monies provided by naive customers.
This type of fraud is very widespread, with dozens of honeypot schemes launched each month on DEXes such as Uniswap, PancakeSwap, and QuickSwap.
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