The EU Innovation Hub for Internal Security has released its first detailed report on encryption, with a strong emphasis on crypto-related issues.

This report, created in collaboration with Europol, Eurojust, and other EU agencies, examines the impact of cryptocurrencies on law enforcement efforts.

It underscores significant gaps in law enforcement’s ability to track and recover illicit digital assets moved through decentralized means such as privacy coins, layer-2 networks, and crypto mixers.

Crypto and Law Enforcement

The report states that cryptocurrencies, which rely on public-private key cryptography, present unique challenges and opportunities for law enforcement.

It details how cryptocurrencies are increasingly used to launder criminal proceeds, complicating the tracing of illicit funds. Emerging technologies like zero-knowledge proofs (ZKP) and Layer-2 (L2) networks, which enhance privacy, may further obscure these funds' origins and movements.

Currently, law enforcement can only recover funds moved via custodial wallets, where users don’t hold their own private keys, by working with exchanges and service providers to seize crypto linked to criminal activity.

This cooperation is crucial, given the strict user identification measures (know-your-customer, or KYC) required by anti-money laundering regulations. However, funds moved via decentralized wallets and addresses remain out of law enforcement’s reach due to the enhanced privacy these technologies offer.

Technological Advancements and Data Obfuscation

The report highlights several advancements that complicate tracking crypto transactions. Privacy coins like Monero obscure transaction details, posing significant tracing challenges despite being less popular than Bitcoin among criminals.

Cryptocurrencies such as Dash and Litecoin offer optional encryption features that enhance transaction obfuscation. The Mimblewimble protocol, used by Grin and Beam, hides transaction details and uses aggregate verification techniques.

ZKPs, used by currencies like Zcash and mixing services like Tornado Cash, verify transactions without revealing details, posing substantial tracing challenges.

Additionally, L2 solutions like the Lightning Network for Bitcoin create payment channels that do not broadcast all transactions to the blockchain, complicating law enforcement tracking efforts.

Future Steps

The report emphasizes the critical need for law enforcement to keep pace with technological advancements and highlights the importance of accessing suspects’ private keys to overcome encryption challenges.

It also calls on state agencies to enhance technical capabilities and foster closer collaboration with crypto exchanges and custodial wallet providers, essential for effectively addressing the misuse of digital assets for criminal purposes.

The report advocates for continued research into “user-controlled” encryption and its impact on digital forensics and decryption capabilities. It also notes the potential of quantum computing to revolutionize cryptographic protocols and stresses the importance of EU funding schemes to support research projects tackling these challenges.

Lastly, the report urges policymakers to prioritize funding to enhance law enforcement’s ability to counteract the misuse of cryptocurrencies.