In today’s digital age, we spend a considerable amount of time online creating data footprints that companies catalogue to use for a host of purposes. Our movements, our speech, our intentions and even our financial transactions are all tracked and catalogued. They are sold on data markets to allow certain companies to create powerful data profiling to reach users and influence them in certain ways.
This data-backed power creep continues to get more powerful with the application of machine learning and AI, and privacy has become increasingly difficult to protect.
If there is one set of data we should be most protective of, it is our financial data, and with bitcoin, we have the chance to wrestle that back from the corporate internet. With the rise of bitcoin, we can start to take ownership of our wealth and avoid custodial tracking and permissioned access to our money.
Bitcoin is a pseudonymous network, anyone can use it simply by spinning up a wallet, but that doesn’t make it anonymous. There is a common misconception that transactions made with bitcoin are inherently private.
This is not exactly the case; if you provide data points that can connect a wallet to your address, you open yourself up to being tracked on the chain. This can be as simple and innocent as posting a public key to your social media profile; that one data point can be used as a jumping-off point to track your blockchain activity. Chain analysis firms thrive on these types of data points along with the information they can secure from KYC on-ramps meaning you might have already created a footprint that doxes your bitcoin holdings.
Since no big incident has happened yet to scare people into privacy best practices, many bitcoin users do not take the necessary steps to safeguard their personal information, leaving themselves vulnerable to prying eyes. As bitcoin continues to capture more of the world’s wealth, your UTXOs become increasingly valuable, and there are people out there who don’t believe in property rights and would want to take them from you.
Chain surveillance is a real threat to bitcoin privacy, but thankfully, we don’t always have to do things on-chain anymore; with second-layer solutions like the Lightning Network, we can start to break tracking assumptions and obscure our interactions between L1 and L2.
The impact of chain surveillance on bitcoin privacy
Blockchains, like bitcoin, are public ledgers that record all transactions, making it easy for anyone to trace a particular transaction back to its origin. This transparency has led to increased chain surveillance, where individuals or organisations monitor the blockchain to identify users and their transactions. Chain surveillance can compromise the privacy and security of Bitcoin users, as their transactions can be linked to their identities.
The impact of chain surveillance on bitcoin privacy is significant, as it can reveal a user’s financial history, spending habits, and even their location. This information can be used by hackers, cybercriminals, or even governments to target bitcoin users. Furthermore, chain surveillance can be used to identify Bitcoin addresses associated with specific entities, such as exchanges or vendors, which can lead to the de-anonymisation of their users.
To protect themselves from chain surveillance, Bitcoin users need to take their privacy more seriously. They can use privacy-enhancing technologies, such as CoinJoin or CoinSwap, that combine transactions from multiple users to make it more difficult to trace a particular transaction back to its origin. Additionally, users can use new addresses for each transaction and avoid using the same address for multiple transactions.
How chain heuristics can be used against you.
Chain heuristics are techniques used to identify patterns and behaviour on the blockchain. By analysing blockchain data, investigators can draw conclusions about a user’s identity and transaction history. Chain heuristics can be used against bitcoin users in several ways.
For example, investigators can analyse the size and frequency of transactions to identify the sender and receiver. They can also analyse the timing of transactions to identify when certain transactions were made.
To protect themselves from chain surveillance, bitcoin users should use privacy-enhancing technologies like CoinJoin or CoinSwaps to mix UTXO sets and start and use new addresses for each transaction. By doing so, users can make it more difficult for investigators to trace their transactions back to their origin.
The issue with this privacy technology is that it doesn’t apply as a standard with wallets; users have to go out of their way to have it setup and always be diligent in how they use these coins going forward to maintain privacy.
You don’t just magically mix coins, and now you have privacy; if you create new data points that link your identity to a UTXO set again because you got sloppy or didn’t realise it, you’ve exposed your coins once again and will have to break assumptions once again.
Mixing coins also becomes expensive, and cheap block space is not always a given, so you need to be smart about when and how you do your mixing.
While CoinJoins are useful in hiding your UTXOs, they also leave a marker that coins have been mixed, which isn’t exactly ideal as certain services may refuse your coins in the future based on the “risk profile.”
The current view on CoinJoin is that people use it for privacy reasons because they have something to hide, and these coins can be labelled as tainted, but what if CoinJoins weren’t only used for privacy? What if they had a practical use case that happened to provide privacy but wasn’t the sole intent?
This is where Lightning network CoinJoins come into play.
Reducing your footprint with the Lightning Network.
The Lightning Network is a second-layer protocol built to tether itself to the bitcoin base chain. To access the Lightning Network, you would need to run additional software on your bitcoin node and then commit a bitcoin UTXO to a channel by broadcasting a transaction to the chain announcing the channel and creating your HTLC or PTLC.
Once you’ve added bitcoin to the Lightning Network, you are free to send and receive bitcoin on this second-layer network, and once you’re done, you can close your channel at any time. Since the Lightning Network is not only about paying peers directly but also routing payments, users are encouraged to maintain a balance on the network to route payments and earn an income.
As more users leverage the Lightning Network, the need for liquidity and new channel opens increases. The more channels available, the easier it is for payments to find paths to their destination.
Everyday peers on the network, from large businesses like exchanges to ordinary plebs like you and me, open and close channels based on their need to access Lightning, so there’s always a steady stream of transactions interacting between the two layers.
Using Lightning, you can commit a transaction of one size and close a transaction of another size based on what you did on Lightning; this can help break some privacy assumptions, especially if you combine your channel open or close with a CoinJoin.
Splice up your bitcoin privacy.
One issue with Lightning is once you establish a channel, you are stuck with the overall capacity you committed on your initial channel open. Suppose you opened a channel for 10 million satoshis or 0.1 bitcoin, and the peer you connected to isn’t effectively routing funds through your channel, so you’re not getting a decent return, and you only actually need to hand them 1 million satoshis or 0.01, you cannot simply reduce the size of your channel; you would need to close it and open up a new one.
This would then free up your other 9 million satoshis back on chain, to either open up other smaller channels or hold on-chain, until you need it on Lightning. As you can imagine, this is highly restrictive when it comes to effectively deploying your capital to Lightning. You would have to calculate if it’s worth paying the on-chain fees to close and open new channels and how long it would take to make that spend back.
This is where splicing comes into play; splicing offers you the ability to get surgical with your channels, and you can carve them up as you see fit.
Suppose you have that same 10 million satoshi channel we used earlier; you could choose to splice it into:
- An on-chain payment of 9 million sats
- Another channel you had open and increase its capacity by 1 – 9 million sats.
- A combination of both a channel rebalance and a secure on-chain balance. Let’s say you increase another channel by 4 million sats and park the other 5 million sats on chain.
Splicing would encourage a lot more transactions between on-chain and off-chain, and this can be coordinated in conjunction with CoinJoins and Dual Funded channels. So let’s take a look at some possible examples of how liquidity management on Lightning can help “trojan horse” in more privacy.
Coordinating your on-chain splices means you’re saving sats to stay private.
Suppose you wish to splice out some funds back on-chain, but some of your peers wish to do the same. Instead of two or three people making three different on-chain transactions, they could combine their splice and perform one on-chain transaction that transfers the funds to the various specified wallets.
Suppose a peer of yours plans to do some spring cleaning and close a few channels, and re-allocate funds. You could even splice between peers and bump up someone else’s channel, and they would settle with you on-chain since that user plans to do several closes.
Channel rebalancing encourages privacy.
In another example, perhaps you have 10 million satoshis on the Lightning Network. You initially established two channels of 5 million each, and it’s pretty easy to see those individual transactions.
One channel is routing payments like crazy, while the other is relatively slow, so you want to reconfigure your funds. You bump up the one channel through a splice and give it 6 million sats, reduce the other channel to 1 million sats, and coordinate with your peers to secure an on-chain transaction of 3 million.
It will be pretty hard to associate that 3 million sat balance with you, and your initial two 5 million satoshi channel opens now.
Dual funding and then splicing.
Let’s say you want to establish a channel with a peer, and the two of you settle on a dual-funded channel to save on transaction fees. You could establish the initial channel creation together and get the funds into the Lightning Network and then splice up the large wumbo channel balance as you please, between the other channels you already have running.
Keep the prying eyes in the dark with dark money.
While the Lightning Network is still relatively new, it is important for bitcoin users to consider all options available and take their privacy seriously. There are several privacy protection methods in bitcoin, and educating yourself on each one can help you find the one that will work best for your situation.
Remember, bitcoin is designed to provide security and is anti-fragile, but you are not; you can be compromised, you can be hacked, and your privacy exposed. Apart from bitcoin adding another block, nothing in this life is a given, so it’s best you prepare for anything and every adversarial possibility by opting for financial privacy.
Are you a bitcoin and lightning fan?
Have you been using Lightning to make micro-payments? Stream sats or engage with apps? Which app is your favourite? Do you run a Lightning node? How do you handle channel rebalancing? Have you tried all the forms of Lightning payments? Which one do you prefer?
Let us know in the comments down below.