IRS Wants to Track ‘Nefarious’ Privacy Coin and Lightning Transactions

The IRS is looking to expand its investigative capabilities around privacy coins, layer-two solutions, and sidechains.

The United States’ Internal Revenue Service (IRS) is seeking information and tools to help it trace transactions using privacy coins, layer two protocols such as Lightning Network and side chains like Plasma and OmiseGo (OMG).

A June 30 request for information published by the U.S. Department Of The Treasury reveals the IRS’ Criminal Investigation Division is seeking submissions for “an interactive prototype” with a graphic user interface for analyzing distributed ledger-based transactions involving privacy coins and other privacy-enhancing blockchain technologies.

IRS peeks into privacy

The document explicitly names Monero (XMR), Zcash (ZEC), Dash (DASH), Grin (GRIN), Komodo (KMD), Verge (XVG), and Horizon (ZEN) among the privacy coins that the IRS hopes to target, in addition to the layer-two solutions Raiden Network, Celer Network, and Lightning.

The IRS requests that prototypes detail systems for “clustering transactions” from a single user who is using “privacy coins and obfuscation technologies”; compile a library of wallet addresses associated with “suspected or known to be involved in nefarious activities”; and identify other addresses associated with said nefarious wallets.

The agency also requests that the system include “a mechanism for sharing investigative research between investigators”, secure data export and import functionality, and estimates on proposed systems’ cost and return on investment. 

Hard to track privacy coins

Despite the bold ambitions of the IRS’ cryptocurrency tracing initiative, the agency acknowledges that few resources currently exist for tracking the movements and addresses of privacy coins:

“Currently, there are few investigative resources for tracing transactions involving privacy cryptocurrency coins, layer-two network protocol transactions, side-chain ledger transactions, or transactions on distributed ledgers that are adopting signature algorithms that provide privacy to illicit actors.”

The regulator also highlighted the dynamic nature of innovation in privacy-enhancing technologies, noting challenges presented by Schnorr Signatures — which were partially implemented by Bitcoin Cash (BCH) last year.

The deadline for prototype submissions is July 14.

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