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European legal authorities raise concerns about privacy coins, Layer-2 networks and crypto mixers
The EU Innovation Hub for Internal Security has published its first comprehensive report on encryption, focusing significantly on encryption issues.
The report, a collaboration between Europol, Eurojust and other EU agencies, delves into the impact of cryptocurrencies on law enforcement efforts.
It highlights significant gaps in law enforcement’s ability to track and recover illicit digital assets moved via decentralized methods such as privacy coins, layer-2 networks, and crypto mixers.
Cryptocurrencies and law enforcement
According to the report, cryptocurrencies, which rely heavily on public-private key cryptography, pose unique challenges and opportunities for law enforcement.
The report highlights how cryptocurrencies are increasingly used to launder criminal proceeds, complicating efforts to trace illicit funds. The rise of technologies such as zero-knowledge proofs (ZKP) and Layer-2 (L2), which enhance privacy, could further obscure the origins and movements of these funds.
The report states that law enforcement can currently only recover funds moved through custodial wallets (where users do not hold their private keys) by working with exchanges and service providers to seize cryptocurrencies suspected of criminal activity.
This cooperation is crucial, given the rigorous user identification (know-your-customer or KYC) measures imposed by anti-money laundering regulations. However, illicit funds moved through decentralized wallets and addresses remain beyond the reach of law enforcement due to the increased privacy afforded by these technologies.
Technological advances and data obfuscation
The report highlighted several advances that complicate the tracking of crypto transactions. Privacy Coins Pleases Monero obscure details of transactions, which present significant tracing challenges despite being less popular than Bitcoin among criminals.
Meanwhile, cryptocurrencies such as Dash AND Litecoin offer optional encryption features that improve transaction obfuscation. Mimblewimble, a protocol used by Grin and Beam, hides transaction details and uses aggregate verification techniques.
ZKP, used by currencies such as Zcash and mixing services such as Tornado Cashverify transactions without revealing details, presenting themselves as substantial track the challenges.
Additionally, L2 solutions such as Lightning Network for Bitcoin create payment channels that do not transmit all transactions to the blockchain, complicating law enforcement tracing efforts.
Future steps
The report highlights the critical need for law enforcement to keep pace with technological developments and highlights that access to suspects’ private keys is critical to overcoming encryption challenges.
The report also urges state agencies to improve technical capabilities and promote closer collaboration with cryptocurrency exchanges and custodial wallet providers, which are essential to effectively counter the misuse of digital assets for criminal purposes.
The report called for continued research into “user-controlled” encryption and its impact on digital forensics and decryption capabilities. He also highlighted the potential of quantum computing to revolutionize cryptographic protocols and said that EU funding programs are vital to support research projects aimed at addressing these challenges.
The report urges policymakers to prioritize funding to improve law enforcement’s ability to combat the misuse of cryptocurrencies.