Risk of USDT freezing: bill and insider trading

USDT Freeze Risk: How the Polymarket Precedent Exposed Stablecoin Vulnerabilities and What to Do About It

Publication Date: October 26, 2024

The insider trading scandal on the Polymarket platform has demonstrated the readiness of US regulators to apply legal mechanisms that can lead to the freezing of crypto assets. This poses a threat to holders of centralized stablecoins like USDT. It is crucial to understand: even funds in a non-custodial wallet can be blocked if the token issuer implements an on-chain freeze at the request of authorities. This article explains the technical and legal mechanisms of blocking and offers a specific action plan to protect your capital.

Timeline of Events: The Polymarket Precedent

• Early 2024: A bet of ~$90,000 was placed on Polymarket regarding the removal from power of Venezuelan President Nicolás Maduro.
• May 2024: Following news of Maduro's possible arrest, the position was closed with a profit of over $400,000.
• October 2024: Congressman Ritchie Torres introduced bill H.R.6152, aimed at combating insider trading in prediction markets. The CFTC and DOJ launched an investigation.
  The investigation served as a signal: existing financial laws will be applied to crypto assets. While the bill does not directly address stablecoins, the tools used by law enforcement pose a direct threat to their holders.

1. Asset Freeze Mechanisms

There are two main ways funds in centralized stablecoins can be blocked.

On-chain Freezing: Technical Capability and Legal Compulsion

Issuers of USDT (Tether) and USDC (Circle) have the technical capability to freeze assets at any address. This function is built into their smart contracts on EVM-compatible blockchains (e.g., Ethereum, Tron) and is managed centrally through addresses with owner rights (owner).

Technical capability becomes a reality through legal compulsion. Upon an official request from law enforcement agencies (e.g., DOJ, FBI) or a court order in the relevant jurisdiction, the issuer is obliged to add an address to a blacklist (blacklist). After this, all tokens at the address become non-transferable. In the USDT smart contract code on Etherscan, functions like addBlackListed and destroyBlackFunds can be found, confirming the ability not only to block but also to destroy funds.

Real-World Precedents:

• Tether (USDT): As of October 2024, Tether has blocked over 1,300 addresses totaling more than $1 billion linked to hacking attacks, fraud, and terrorist financing. The company regularly cooperates with law enforcement agencies worldwide.
• Circle (USDC): In August 2022, Circle blocked addresses associated with the Tornado Cash mixer after it was added to the OFAC sanctions list. This was the first major case of freezing funds in non-custodial wallets at the request of a regulator.

Off-chain Blocking: Centralized Exchanges (CEX)

Exchanges and OTC desks are required to comply with international Anti-Money Laundering and Countering the Financing of Terrorism (AML/CFT) standards. If your account receives assets flagged by analysis systems as high-risk (e.g., from mixers, darknet markets, or sanctioned wallets), the exchange will freeze the account and request Proof-of-Funds.

2. Comparison of Popular Stablecoins

Risks depend directly on the stablecoin's architecture. Moving assets to a non-custodial wallet protects against exchange blocking but not against on-chain freezing by the issuer.

Stablecoin	Architecture	Presence of Freeze Functions (blacklist/freeze)	Key Risks	Storage Recommendations
USDT, USDC	Centralized (fiat-collateralized)	Yes (addBlackListed, destroyBlackFunds, etc.). Confirmed by public precedents.	Freeze by regulatory request, counterparty risk (issuer bankruptcy).	For short-term operations and trading. Not recommended for long-term storage of large sums.
DAI	Decentralized (DAO-managed)	No (for individual addresses).	Governance risks: the DAO could block collateral types (e.g., RWA), affecting stability.	For long-term storage. Requires monitoring of DAO decisions and collateral composition.
USDD, FRAX	Algorithmic / partially collateralized	Varies by implementation (often Yes). Must check each contract.	De-peg risk, risks of centralized collateral components, governance risks.	For experienced users willing to accept high risks.

3. How to Verify a Token's Smart Contract

Before storing significant amounts in any token, verify its contract.
Important: The check must be performed for the specific contract address on the specific network (e.g., USDT on Ethereum and USDT on Tron have different contracts).

1. Find the contract address on Coingecko or a block explorer.
2. Examine the code manually. In the explorer (Etherscan, TronScan), open the Contract tab and search the verified code for keywords: blacklist, freeze, pause, owner, destroy.
3. Check access rights. On the Read Contract tab, look for owner() or pauser() functions. If they point to a single address (EOA) rather than a smart contract with a Timelock or multi-sig (multisig), the risk of centralized interference is maximized.
4. Analyze events. On the Events tab, look for Blacklisted, Freeze, or Pause events. Their presence confirms that the issuer has already used these functions.

Programmatic Verification (Etherscan API example):

You can automate the keyword search in the contract source code using an API.

API_KEY="YourApiKeyToken"
CONTRACT_ADDRESS="0xdac17f958d2ee523a2206206994597c13d831ec7" # Example: USDT on Ethereum
curl "https://api.etherscan.io/api?module=contract&action=getsourcecode&address=${CONTRACT_ADDRESS}&apikey=${API_KEY}" | grep -Ei "blacklist|freeze|pause"

Any result in the output indicates the presence of centralized control functions.

Checklist: Practical Steps for Asset Protection

1. Diversify Stablecoins and Use Non-Custodial Wallets.

   • Store core capital on hardware wallets (Ledger, Trezor).
   • Distribute funds between centralized (USDT, USDC for liquidity) and decentralized (DAI for storage) stablecoins.
   • Bridge Risk: Remember that wrapped tokens on other networks inherit centralization risks. For example, USDC.e on Avalanche can be frozen by blocking the original USDC on the bridge within the Ethereum network.

2. Maintain AML Hygiene and Verify Counterparties.

   • Before receiving a large sum, check the sender's address via AML services (Crystal, Chainalysis KYT, Elliptic). This reduces the risk of receiving "toxic" funds.
   • Use separate, "clean" wallets for P2P operations, without mixing funds with your main capital.

3. Prepare Proof-of-Funds.

   • Document all major transactions in advance. If an exchange issues a request, you will have a ready documentation package.

   Field	Example
   Transaction ID (TxHash)	0x…
   Date and Time	2024-10-26 15:30 UTC
   Amount and Asset	10,000 USDT
   Transaction Context	Payment for invoice #123 / P2P trade with @username
   Supporting Documents	Chat screenshot, PDF invoice, P2P order link

4. Develop a Response Plan for CEX Requests.

   • Upon receiving a request from an exchange regarding the origin of funds, provide a brief, formal response with attached documents.

   Response Template:

   Dear [Exchange Name] Support Team,

   In response to your request regarding transaction [Transaction ID] from [Date], I am providing the following information about the origin of the funds.

   These funds were received as a result of [source description: NFT sale, freelance payment, P2P exchange].

   As confirmation, I have attached the following documents:

   1. Screenshot of the trade/chat.
   2. Invoice/contract.
   3. Transaction hash in the block explorer.

   I am available to provide further clarification if needed.

   Sincerely,
   [Your Name / Company Name]

Conclusion: From Passive Storage to Active Risk Management

The Polymarket incident confirmed that regulatory pressure on the crypto industry will only intensify. Passive storage of assets, even in your own wallets, no longer guarantees complete security. Key steps for capital protection now include:

1. Technical verification of the smart contracts for the assets used.
2. Strategic diversification between centralized and decentralized stablecoins.
3. Documentation of transactions to prove the legal origin of funds.

These actions are becoming mandatory elements of digital hygiene for everyone working with crypto assets.

Glossary

• CEX (Centralized Exchange): A centralized exchange (e.g., Binance, Coinbase).
• DEX (Decentralized Exchange): A decentralized exchange (e.g., Uniswap, Curve).
• AML/KYT (Anti-Money Laundering / Know Your Transaction): Procedures for combating money laundering and analyzing transactions.
• DAO (Decentralized Autonomous Organization): An organization managed by a protocol through token holder voting.
• P2P (Peer-to-Peer): Direct transactions between users without intermediaries.
• HODL: Long-term holding of crypto assets.

Sources and Useful Tools

1. Bill H.R.6152:
   Public Integrity in Financial Prediction Markets Act
2. Tether Transparency Report:
   Tether Transparency Report
3. Tornado Cash and USDC Precedent:
   Coindesk Report
4. Blockchain Analysis Tools:
   Etherscan, TronScan, Tenderly
5. AML Services:
   Crystal Blockchain, Elliptic