A new report from the EU has singled out Bitcoin's Lightning Network and other layer 2 solutions as "data obfuscation" technologies that could be "abused by criminals."

The First Report on Encryption by the EU Innovation Hub for Internal Security, a "collaborative network of innovation labs" from across EU member states, argues that alongside technologies including Mimblewimble, zero-knowledge (zk) proofs, coin mixers and privacy coins such as Monero and Zcash, "layer 2 solutions such as the lightning network might also be abused by criminals."

The report notes that the Lightning Network's "two-party multisignature payment channels will not broadcast all transactions to the blockchain, but only the opening and closing of the channel," adding that it and other layer 2 solutions could cause cause "problems for law enforcement investigations."

Privacy coins and law enforcement

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The report also takes aim at coin mixers such as Tornado Cash, and privacy coins including Monero, Zcash, Grin and Dash.

It highlights their use of "zero-knowledge proofs and layer 2 solutions" that enable some transaction data to be obscured, which "significantly complicates tracing the origins of (illicit) cryptocurrency for law enforcement."

Cryptographic protocol Mimblewimble, used by cryptocurrencies including Grin, Beam and Litecoin, is considered a "complicating factor," in law enforcement's efforts to trace cryptocurrency transactions, though the report's authors conced that, "transactions using Mimblewimble are not frequently encountered."

Privacy coins have been subject to regulatory pressure from governments in recent months.

The EU's Markets in Crypto Assets (MiCA) framework, which comes into force at the end of 2024, cracks down on interactions between crypto-asset service providers (CASPs) and privacy coins, prompting crypto exchanges such as Binance to delist them.

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Crypto mixers have also come under pressure from law enforcement agencies around the world, with Tornado Cash developer Alexey Pertsev found guilty of money laundering by a Dutch court.

In April, U.S. authorities arrested and charged the founders of Bitcoin mixer Samourai Wallet with conspiracy to commit money laundering. The crackdown has had a chilling effect on other privacy tools, with several coin mixing services abandoning the U.S. in the wake of the Samourai Wallet arrests.

Edited by Stacy Elliott.

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