Lightning Network Privacy: Pros & Cons vs. Bitcoin's Base Layer

Basic approach to the privacy on the Lightning Network

In this article i would like to make a short recap of pros Pros & Cons of the Lightning Network vs. Bitcoin's Base Layer. The goal is not to examine all features and tradeoffs but to give a basic idea of the different approach Lightning Network to this important aspect.

Pros

• Off-Chain Transactions & Aggregation: Transactions on the Lightning Network occur off-chain and are only settled on the Bitcoin blockchain when a channel is closed. This provides greater privacy compared to the base layer where every transaction is permanently recorded and publicly viewable

• LN only reveals the final balance changes upon channel closure, hiding individual transactions

• Onion Routing: LN uses onion routing to encrypt payment paths, ensuring intermediary nodes only know the previous and next hops, not the sender or receiver. This makes tracing payments challenging, especially for smaller, more frequent transactions. However, large payments may have fewer possible routes and become easier to track

• Ephemeral Transaction Data: Transaction data on LN is only stored by involved nodes, making historical analysis difficult

• Unlike the persistent record on Bitcoin's blockchain, this ephemeral nature hinders efforts by chain analysis companies to track payments

Cons

• On-Chain Footprint: Opening and closing LN channels necessitate on-chain transactions that are publicly visible and analysable. This creates a "digital fingerprint" that may be used to link on-chain and LN activity. While Taproot and Schnorr signatures can improve privacy by making funding transactions look like any other Bitcoin transaction, unilateral channel closures (at the moment) still reveal distinctive scripts and timings that can expose LN usage.

• Public Channel Announcements: Most LN nodes publicly announce their channels to facilitate routing, including the channel's funding transaction. This can link a user's LN node with their on-chain activity. Even though wallets typically don't announce their channels, invoices for payments through unannounced channels still leak information about the channel and potentially associated UTXOs.

• Invoice Data & Receiver Privacy: LN invoices contain the receiver's public key, and invoices using unannounced channels also include routing hints exposing channel details. This significantly compromises receiver privacy. Solutions like rendez-vous routing aim to improve this by allowing payments without revealing the receiver's public key.

• Attacks & Vulnerabilities: While onion routing provides protection, LN is still vulnerable to attacks like probing, where attackers try to determine channel balances by sending varying amounts of payments.

• Timing analysis can also be used to infer payment paths and participants. Mobile wallets are particularly vulnerable as they often have a single connection to an LSP, enabling potential tracking by the LSP.

• Centralisation Concerns: Solutions like trampoline routing, while offering privacy benefits, may contribute to centralization on LN as large, well-connected nodes become preferred intermediaries. Additionally, some proposed privacy enhancements may increase the complexity and cost of running LN nodes, potentially hindering wider adoption.

Public vs. Private Channels on the Lightning Network

The main difference between public and private channels on the Lightning Network lies in how they are announced and consequently used for routing payments:

Public channels are announced to the rest of the network via a channel announcement message. This message informs other nodes of the channel's existence and its corresponding UTXO (Unspent Transaction Output), allowing them to route payments through it.

Because this information is publicly broadcast, anyone running a Lightning node can see the channel and its capacity, which refers to the total amount of Bitcoin locked in the channel. This makes public channels more easily traceable and potentially less private than private channels.

Private channels, on the other hand, are not announced to the wider network. Only the two parties involved in the channel are aware of its existence. This means that other nodes cannot route payments through a private channel, making it more difficult for third parties to track the movement of funds.

Although touted as "private," it's crucial to understand that these channels are simply unannounced. They can still be analyzed through various means. For instance, if one party to a private channel subsequently uses the funds to open a public channel, the original private channel can be linked to that public channel and its associated node.

Here's a table summarising the key differences:

Implications for Users:

• Wallets generally use private channels to enhance privacy, as they do not need to announce their channels to route payments.

• Routing nodes, however, need to announce their channels (public channels) to participate in the network and earn routing fees.

• Merchants who only receive payments also do not need to announce their channels, benefiting from the privacy of private channels.

Things to pay attention to:

• While private channels offer better privacy, they can be inadvertently revealed through invoices. If an invoice containing details of a private channel is posted publicly (e.g., on Twitter or other social media), the channel becomes known to anyone who sees the invoice.

• Technologies like route blinding are being developed to address this issue by obscuring the recipient's node ID and channel details in the invoice, thereby enhancing receiver privacy.

• Despite their privacy advantages, private channels can impact routing efficiency. Since the network is unaware of their capacity, they may not be prioritized for routing, potentially leading to slower or more expensive payments.