In its inaugural report on encryption, the EU Innovation Hub for Internal Security examined how privacy coins and mixing protocols complicate regulatory efforts.

Data encryption can help balance individual privacy and collective security. However, cryptocurrency mixing protocols may face significant challenges for European legislative acceptance.

EU Innovation Hub's Report on Encryption

The EU Innovation Hub, a collaborative initiative involving members from various European Union agencies and member states, has published its first report on encryption. The report highlights the "dual-use" nature of cryptographic technologies, recognizing their potential for both positive and negative applications.

The Good and Bad in Crypto

The report acknowledges the importance of public-private cryptography for the functioning of cryptocurrencies and nonfungible tokens (NFTs) in areas such as storage, mining, and transfers. However, it also points out that some bad actors exploit these technologies to evade law enforcement. Specifically, it identifies protocols and privacy coins that "obscure" visibility on the blockchain as problematic.

The report calls out several cryptocurrencies and technologies, including Monero (XMR), Zcash (ZEC), Grin (GRIN), Dash (DASH), layer-2 initiatives, zero-knowledge proofs, crypto mixing services, and noncompliant crypto exchanges, for making it easier for bad actors to launder funds.

Challenges Posed by Mixers and Privacy Coins

The report notes that mixers and privacy coins have long complicated the tracing of illicit activities. However, it also highlights new developments such as Mimblewimble and zero-knowledge proofs, which further obscure the visibility of cryptocurrency addresses, balances, and transactions.

Decrypting Hidden Trails

Despite these challenges, the report asserts that law enforcement authorities can still investigate such activities if they gain access to the private keys of suspects. It cites the use of services like Tornado Cash by crypto hackers and scammers to obscure stolen funds but emphasizes that law enforcement can track these transactions when appropriate measures are taken.

EU Innovation Hub Members

The report was created by six members of the EU Innovation Hub for Internal Security: Europol, Eurojust, the European Commission’s Directorate-General for Migration and Home Affairs, the European Commission’s Joint Research Center, the European Council’s Counter-Terrorism Coordinator, and the European Union Agency for the Operational Management of Large-Scale IT Systems in the Area of Freedom, Security, and Justice.

Legal Implications

The report also touches on the legal implications for developers of cryptocurrency mixing protocols. Alexey Pertsev, the developer of Tornado Cash, was found guilty of money laundering in May, highlighting the potential legal risks for developers of similar open-source projects. Despite Tornado Cash being a noncustodial crypto mixing protocol, Pertsev's conviction underscores the challenges developers face in navigating the regulatory landscape.

Ongoing Issues with Tornado Cash

Amid Pertsev’s legal battles, a recent incident involving a cross-chain bridge exploiter using Tornado Cash to siphon $47.7 million of stolen funds demonstrates the ongoing issues law enforcement faces in tracking and prosecuting such activities.

Conclusion

The EU Innovation Hub’s report underscores the delicate balance between leveraging cryptographic technologies for legitimate purposes and preventing their misuse by bad actors. While encryption can enhance privacy and security, the use of privacy-focused cryptocurrencies and mixing services presents significant challenges for regulatory authorities. The report suggests that continued innovation in law enforcement techniques and regulatory frameworks will be essential to address these challenges effectively.