IRS seeks info on tracing privacy coins, Lightning network transactions for pilot program

Quick Take

  • The IRS is collecting information for a cryptocurrency investigation pilot program.
  • Specifically, the IRS is seeking information about software applications it can use to track transactions tied to privacy coins and layer-2 protocols like Lightning.

The U.S. Internal Revenue Service (IRS) has put out a call for information about potential tools it can use to track different types of cryptocurrency transactions as part of an investigative pilot program.

Information about the pilot is contained in a newly-published request for information made public by the agency on June 30. As described, the pilot features several areas of focus, including privacy coins and layer-2 transaction protocols like the Lightning network. Prospective bidders have until July 14 to submit their responses.

As the IRS explains:

"This RFI is associated with a pilot IRS Criminal Investigation Division (CI) program. CI Cyber Crimes is requesting information about systems that will allow developers and testers to conduct investigative research of distributed ledger transactions involving privacy cryptocurrency coins (e.g., Monero (XMR), Zcash (ZEC), Dash (DASH), Grin (GRIN), Komodo (KMD), Verge (XVG), and Horizon (ZEN)); Layer 2 off-chain protocol networks (e.g., Lightning Network (LN), Raiden Network, Celer Network); Side-chains (e.g., Plasma and OmiseGo); and tracing challenges following the integration of the Schnorr Signature algorithm."

The IRS further stressed that such tools would provide a boon to investigators looking to pierce the veil of anonymity associated with the transactions it traces.

"Acquiring applications to allow an investigation to more easily trace privacy coins and other protocols that provide anonymity to illicit actors would allow investigations to be more effective, as well as facilitate a higher level of deterrence by making it harder to conceal criminal activity. It also provides an investigative efficiency that is currently limited," the RFI document explains.

The agency's notice acknowledges that "there are few investigative resources for tracing transactions" in these areas that and "[t]he CI Cyber Crimes program is working to get in front of this trend through this RFI."

On second-layer protocols like Lightning and Raiden in particular, the IRS stated that "[e]ven though Layer 2 protocols have been dismissed by many in the investigative support community, there is clear evidence that this is a growing network."

As The Block previously reported, the IRS has made no secret about its ambitions to beef up its investigative capabilities.

Earlier this year, the IRS was among a group of agencies seeking more funding from Congress to fuel such expansions, as The Block reported. The IRS said it wanted $40.54 million to "Expand Cyber and Virtual Currency Compliance Efforts," according to public documents.

More recently, the IRS emerged as one of several agencies being pitched on analytical tools developed by crypto exchange Coinbase. The public listing on the U.S. government's SAM database appears to have become inactive since The Block's report.

The IRS held a summit in March with the direct goal of connecting its staffers with members of the crypto industry, offering a kind of crash course into the particulars of the technology as well its implications for the U.S. tax authority. It was during that event that representatives of U.S.-based exchanges called for greater clarity on the regulatory front.

Read the full IRS RFI document below:

Cryptocurrency+Tracing-RFI+FINAL by MichaelPatrickMcSweeney on Scribd

© 2022 The Block Crypto, Inc. All Rights Reserved. This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.

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