Crypto Mixers, Privacy Coins, Layer 2s Complicate Tracing for Law Enforcement, EU Innovation Hub Says

Privacy coins, mixers and layer-2 platforms can make it difficult for law-enforcement agencies to trace funds, according to a report from the European Union's Innovation Hub for Internal Security, a network of labs supporting internal security organizations in the 27-nation bloc.

The report, published Monday by crime-fighting agencies including Europol and Eurojust with the European Commission and others, told law enforcement agencies they need to be prepared to encounter those types of tools in their investigations.

Crypto mixers have recently been in the spotlight. Tornado Cash developer Alexey Pertsev was sentenced to spend more than five years in jail by a Dutch court after prosecutors successfully argued the platform was created for money laundering. Tornado Cash allows crypto users to exchange tokens while hiding wallet addresses on the Ethereum, BNB Chain, Arbitrum, Avalanche and Optimism networks.

"Mixer Tornado.cash has also been using zero-knowledge proofs to enable users to withdraw funds from the mixer without revealing what their original deposit was," the report said. "This significantly complicates tracing the origins of (illicit) cryptocurrency for law enforcement."

Privacy coins like Monero build privacy into their protocols, hiding the identities of the sender, the receiver and even the money being sent.

"Layer 2 solutions such as the Lightning Network might also be abused by criminals," the report said. "This can be used, for example, to make payments to each other without making times and amounts of these payments visible. Similarly, new wallet encryption schemes may also complicate lawful access by law enforcement."

Separately, France's Autorité des Marchés Financiers (AMF) said crypto remains a high risk for money laundering due to its popularity, cross-border nature and anonymity that comes with platforms like mixers. The securities regulator published its own report on Monday.