Bitcoin’s Lightning Network is now under surveillance by US government spooks

Blockchain analytics unit Chainalysis now sells Lightning surveillance as a service, for the discerning US agency worried about Bitcoin.

Blockchain analytics unit Chainalysis now has Bitcoin’s Lightning Network under surveillance. The firm says this new capability will assist customers’ security and compliance needs.

Chainalysis will add Lightning tracking to its “Know-Your-Transaction” (KYT) offering by next quarter. KYT already monitors activity on Bitcoin and Ethereum, including illicit behaviors flagged by the US Office of Foreign Assets Control (OFAC).

Chainalysis cited Lightning’s growing popularity as motivation for expanding its surveillance suite. Today, users hold over 3,400 BTC ($162 million) within the Lightning Network.

This amount represents a significant increase over Lightning’s 468 BTC ($22.3 million) one year ago.

Chainalysis frequently works with U.S. government agencies during investigations and regulatory enforcement actions related to cryptocurrencies and blockchain.

The New York-headquartered company has earned at least $10 million from government contracts — more than competitors CipherTrace and Elliptic. Its first contract was a $9,000 data analysis deal with the Federal Bureau of Investigation (FBI) in 2015.

Chainalysis has also done work for US agencies like the Commodities Futures and Trade Commission (CFTC), Drug Enforcement Agency (DEA), Internal Revenue Service (IRS), and Securities and Exchange Commission (SEC) among others.

A refresher on layers

Lightning is Bitcoin’s most popular way for users to reduce fees and increase throughput on the blockchain’s base layer.

This “layer 2” scaling solution uses Bitcoin smart contracts to link users via payment channels.

  • Users enter the Lightning Network by signing a two-of-two multi-signature transaction onto Bitcoin’s blockchain.
  • They can now route payments through Lightning’s mesh network, incurring negligible fees and near-instant clearance of funds.
  • These transactions transmit within Lightning and do not require larger miner fees for standard inclusion in a block.

Once users have concluded their Lightning activities, they exit the network and settle with finality onto Bitcoin’s blockchain by closing their payment channel.

This requires one more miner fee, bringing the total mining fees to two — in consideration for hundreds or even thousands of layer 2 transactions.

In essence, the Lightning Network adds levels of complexity that can make transactions difficult to track (although, Bitcoin’s Taproot upgrade this year opened doors for enhanced privacy).

Lightning against surveillance

The Bitcoin blockchain does not record transactions while funds are still locked in Lightning Network payment channels. A blockchain can only log activity when a Lightning user funds or closes a payment channel, but not activities in-between.

Hashed Timelock Contracts (HTLCs) do allow applications like Lightning to return funds to their senders if users do not satisfy specific conditions.

Atomic swaps typically use HTLCs for trustless crypto trades (if the buyer does not meet the swap requirements, the BTC returns to the seller as the HTLC closes).

So, Lightning can make it challenging to know exactly who received Bitcoin until the final settlement onto the base blockchain.

Blockchain guru Andreas Antonopoulos recently went deep on the Lightning Network and its development in this 50-minute podcast.

Read more: [Lightning Network bot hack perfectly demonstrates it’s not Bitcoin]

In 2019, Chainalysis reported that illicit activity accounted for just 1.1% of all Bitcoin transactions. That number is growing year-on-year; government agencies are increasing budgets for tracing crypto.

Chainalysis says it could detect 90,000 open public Lightning channels as of December 1, up from 38,000 at the start of the year.

Now, it can monitor them.

Chainalysis against on-chain privacy

Chainalysis’ first surveillance tool crawled Bitcoin’s blockchain and mempool through its Reactor product. Reactor can flag transactions that include an address suspected of being used for criminal activity.

Agencies and departments that often deal with cybersecurity technologies include the IRS’ Cyber Crimes Unit (IRS:CI). IRS:CI has a $3.3 million contract with Chainalysis for “Case Support and Training.”

As part of the IRS’ Criminal Investigations division, the Cyber Crimes Unit has used Chainalysis’ tools for operations like busting a child pornography ring based in South Korea.

Many agencies do not publicly comment on their investigative techniques. However, one of Vice’s FOIA requests revealed that ICE’s Homeland Security Investigations unit also used Reactor and signed a $13,188 contract with  Chainalysis.

The IRS also awarded a $625,000 contract to Chainalysis and Integra FEC to crack Monero’s privacy features and develop the ability to trace other layer 2 protocols like Lightning.

Chainalysis appears to have succeeded with Lightning. The highly private Monero may remain an intractable enigma (but rival analytics unit CipherTrace does claim it can track Monero).

Chainalysis is the first to offer Lightning surveillance as a service.

It should also be noted that many Lightning users route transactions privately through an onion network like Tor.

Onion networks randomly route data packets through connected devices until they reach their destination. With all the data randomly bouncing throughout the network, an outside observer may find it challenging to track whole messages.

This means that historically, Lightning made it difficult for third parties to conduct mass surveillance without permission.

Privacy advocates champion Lightning for exactly this reason (the US Constitution grants a right to privacy on all citizens, and there are similar privacy rights abroad).

Chainalysis has just introduced a product that could degrade that value proposition — to the detriment of all Bitcoin users.

Follow us on Twitter for more informed crypto news.