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Lightning Network ‘an obstacle for criminal investigations,’ says Europol

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The Lightning Network is interfering with law enforcement’s ability to trace the proceeds of ‘crypto’ crime, according to a new report from Europe’s top cops.

A new report by the European Union Innovation Hub for Internal Security—whose members include EU law enforcement agency Europol and the European Council’s Counter-Terrorism Coordinator—examines the use of encryption from a legislative, technical and developmental viewpoint. The First Report on Encryption notes that the technology presents “an obstacle for criminal investigations, especially in relation to evidence admissibility.”

The report was constructed to help resolve the ongoing dispute between data privacy and lawful interception (LI) in the hope of achieving “a balanced approach, where LI can coexist with encryption without undermining cybersecurity and/or privacy.”

Europol has been sounding the alarm over privacy-enhanced blockchain tools for years now, and the new report includes a section on cryptocurrencies, which it says are “widely used for laundering criminal proceeds.” The report warns of “concerns that tracing funds will become more complicated if zero-knowledge proofs and layer 2 applications are more widely deployed in the blockchain.”

So-called Layer 2 applications—like Blockstream’s Lightning Network—are generally employed as scaling solutions for blockchains that lack the ability to handle a sufficient volume of transactions. These constricted chains also impose punitive fees on the few transactions that are capable of being handled on a network’s main layer.

Prominent blockchains such as BTC, Ethereum and others suffer from this limitation, largely as a result of their developers’ preference for shunting transactions off primary layers and onto proprietary Layer 2s. Many of these Layer 2s are run by the same developers who limit main-layer bandwidth, setting up an obvious conflict of interest that lines these developers’ pockets at the expense of wider consumer adoption.

The report notes that Layer 2 solutions such as Lightning “will not broadcast all transactions to the blockchain, but only the opening and closing” of individual payment channels on the secondary layer. Criminals could utilize this extra level of obfuscation “to make payments to each other without making times and amounts of these payments visible.” Other blockchains’ implementation of Layer 2 solutions “might cause additional problems for law enforcement investigations.”

The EU report flagged similar concerns with so-called privacy coins like Monero, Zcash, Grin and Dash, as well as the growing use of coin mixers to obfuscate the trail of digital assets that are often the proceeds of crime or funds flowing to terrorist groups.

European authorities have been paying closer attention to mixers in recent years, including cooperating with their global counterparts to take down some of the major players. Last month, one of the co-founder developers behind Tornado Cash, a leading mixer on the Ethereum network, was sentenced to 64 months in prison by a Dutch court.

Lightning in a bottleneck

Blockstream’s normally chatty CEO Adam Back has so far offered no public comment whatsoever on the EU report. Back is probably banking on the fact that Europol will focus most of its attention and resources on the other concerning aspects of ‘crypto’ cited in the report (privacy coins, mixers) because—unlike Lightning—those technologies actually work.

Lightning was supposed to bring about a tsunami of small-scale retail use cases for the BTC token, but this tidal wave never materialized. For one thing, customers who paid an initial on-chain fee to join a Lightning channel found themselves having to pay again once their ‘Lightning Bucks’ ran out and they needed a top-up, then paid yet again once they’d had enough and sought an exit.

A lot of Lightning users weren’t necessarily power users, just individuals who’d been told that Lightning offered myriad ways to finally use their BTC tokens for something other than sitting and waiting for them to magically increase in value.

But once onboarded (Offboarded? Unchained? Sold down the river?), they encountered a buggy AF system that, more often than not, required multiple attempts at transacting, and even that didn’t guarantee a favorable result. (‘Screw it, I’ll pay cash for the damn coffee.’)

The whole Lightning system could also become unworkable should on-chain fees grow so large that opening a Lightning channel no longer makes economic sense. That’s not an idle concern; just last week, BTC fees topped $82 and were as high as $128 on April 20th. Last week’s fee spike was due to a backlog of 300,000 unconfirmed transactions.

But with developers giving up on Lightning due to its inherent fragility, and the number of BTC tokens committed to the network recently falling back below its post-FTX-bankruptcy levels—also below what all Lightning-based startups have raised via funding rounds—we may soon be paraphrasing Richard Nixon and no longer have Lightning to kick around anymore.

If only there was some real-world example of a Layer 1 blockchain that could not only scale to match whatever volume of transactions were thrown at it but could also process each of those transactions at the cost measured in fractions of a penny. Gosh, that would be swell, wouldn’t it?

A very high level of merde

This week also saw the release of a new report by France’s financial regulator Autorité des Marchés Financiers (AMF) that didn’t join in on the Billy Batts-style kicking of Lightning. At least, not by name.

Instead, the AMF report focused on digital assets’ unfortunate intersection of money laundering and terrorist financing. The report (viewable here, en français) says these issues present “a very high level of risk for the digital assets sector” and this likelihood “justifies very close monitoring” of the sector.

The AMF says the total transaction volume of French-licensed digital asset platforms hit €41 billion ($44.1 billion) in 2023. And yet, “despite all mitigation measures, the residual vulnerability of digital assets [to money laundering and terror financing] remains high.”

The AMF claims digital assets are “susceptible to misuse” in a broad variety of illicit purposes due to “the transnational and almost immediate nature of transactions, the opacity of exchange channels, and the volume of transferable values.”

The AMF flags the “leading role” that exchanges play in this misuse by making it possible to convert digital assets on “traceable blockchains” to tokens on “less traceable blockchains guaranteeing the anonymity of transactions.” The AMF also casts a critical eye on “certain private blockchains which do not allow access to transaction data or wallet addresses involved in these transactions.”

While that ‘certain private blockchains’ language could technically apply to Lightning, nobody is using Lightning for money laundering, as the whole point of laundering is ensuring funds get from Point A to Point B. Which, as we’ve seen, isn’t a given on Lightning.

And no self-respecting terrorist wants to have to come back to their humorless supreme leader and say, “um, so Project Things Go Boom will have to be delayed, as our funding has been depleted by those stupid on-/off-ramp fees.” Here that, law enforcement? Guess there’s an upside to Lightning after all!

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