IRS To Track Nefarious Privacy Coin And Lightning Transactions

IRS Targets Privacy Coins and Layer-Two Protocols with New Tracking Tools Initiative

The Internal Revenue Service (IRS) is ramping up efforts to trace cryptocurrency transactions involving privacy coins and layer-two protocols, according to a request for information issued on June 30. The initiative aims to equip the IRS Criminal Investigation Division with tools to analyze complex blockchain transactions, improving its ability to identify and track illicit activities.

IRS Focuses on Privacy Coins and Layer-Two Solutions

The IRS is specifically targeting privacy-focused cryptocurrencies and advanced blockchain protocols, including:

• Privacy Coins: Monero (XMR), Zcash (ZEC), Dash (DASH), Grin (GRIN), Komodo (KMD), Verge (XVG), and Horizon (ZEN).
• Layer-Two Solutions: Lightning Network, Raiden Network, and Celer Network.
• Side Chains: Plasma and OmiseGo (OMG).

These technologies often incorporate features like anonymity and transaction obfuscation, making them popular among users seeking privacy but also raising concerns about illicit activities.

Key Requirements for the Prototype

The IRS has outlined specific requirements for the proposed tools, including:

1. Clustering Transactions: Grouping multiple transactions from a single user utilizing privacy features or obfuscation techniques.
2. Wallet Address Database: Creating a library of addresses linked to “suspected or known nefarious activities.”
3. Association Identification: Mapping other addresses connected to wallets flagged for illicit use.
4. Investigator Collaboration: Enabling data sharing and collaborative research between investigators.
5. Secure Data Handling: Ensuring secure import/export of sensitive data.
6. Cost Analysis: Providing estimates for the system’s cost and potential return on investment.

Challenges in Tracing Privacy Coins

The IRS acknowledges the difficulty of tracing privacy-enhanced blockchain transactions due to advanced cryptographic techniques.

IRS Statement:
“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.”

Despite the complexity, the agency views the development of such tools as a critical step in combating financial crimes involving cryptocurrencies.

Deadline and Next Steps

The IRS has set July 14 as the deadline for prototype submissions. Developers and blockchain firms interested in contributing must provide a detailed proposal, including interactive prototypes with graphic user interfaces, to showcase their ability to address the IRS’s requirements.

Implications for the Crypto Industry

This initiative signals a heightened regulatory focus on privacy coins and advanced blockchain technologies. While some in the crypto community may view this as a challenge to privacy rights, others see it as a necessary measure to deter illicit activities.

The move aligns with broader global efforts to regulate and monitor cryptocurrency transactions. It also highlights the growing tension between privacy advocates and regulatory agencies aiming to maintain transparency in financial systems.

Conclusion

The IRS’s push to develop tools for tracking privacy coin transactions and layer-two solutions underscores the agency’s commitment to addressing the challenges posed by blockchain technology. This initiative may significantly impact the future of privacy-focused cryptocurrencies, paving the way for increased scrutiny and regulatory oversight in the crypto space.

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