The major characteristic of a fully public ledger like Bitcoin is that all transaction information is available to everyone. This means that all transaction amounts and addresses are visible on the blockchain, making it possible to trace the flow of funds and link transactions to specific individuals.
This lack of privacy can be concerning for several reasons. First, it can compromise the financial privacy of individuals who may not want others to know how much they are sending or receiving. Second, it can make it easier for criminals to track and target individuals who have large amounts of Bitcoin. Finally, it can be a concern for businesses that may not want their financial transactions to be visible to competitors or the general public.
To address some of these privacy concerns, the Lightning Network was developed as a second-layer solution on top of the Bitcoin blockchain. The Lightning Network is designed to enable faster and cheaper transactions while also improving privacy.
What is the Lightning Network
Lightning Network is a scalable Layer 2 network on top of the Bitcoin blockchain that aims at providing fast, secure, private, trustless, and permissionless payments with the use of payment channels. A payment channel is a financial relationship between two nodes on the Lightning Network, typically implemented by multi-signature Bitcoin transactions that share control over bitcoin between the two Lightning nodes.
A major difference is that lightning payments happen off-chain(between the nodes), the only transactions recorded on-chain are the transactions to open a new channel or close and settle an existing payment channel.
Lightning still relies on the underlying security and consensus of the bitcoin blockchain, but payments are done “off-chain”.
Improved privacy is one of Lightning's key selling points; hence, this article will concentrate on that. I'll assume you have a fundamental understanding of lightning transactions, but if not, the lightning book's chapter on the lightning (found at https://github.com/lnbook/lnbook/blob/develop/01 introduction.asciidoc) is a great place to start. So now let's talk about privacy
Even though privacy seems to be talked about a lot when referring to lightning, there is still an ongoing debate as to if it is private or not, and just like many concepts in BItcoin we have people on both ends of the debate. My goal is to try to highlight some of the core concepts been talked about.
How lightning helps privacy
The majority of the ways to transact privately over the Lightning Network, in my opinion, rely on how highly the intended user values privacy, but generally speaking, Lightning offers the following instant privacy advantages:
Smaller on-chain footprint: Most of the lightning payments happen off-chain i.e between nodes on the lightning network and thus this is hidden from the broader bitcoin network.
Onion Routing: For payments to move from node A to node B on the lightning network, payments have to be routed via intermediate/relay nodes and in most cases, the connecting node only knows the immediately preceding and following node along the route. This is particularly good for the sender's privacy. Receivers do not have the same privacy as they will need to give out revealing information.
Tor-based node: In lightening, we have the option of running a tor-based node which means we can run a node without exposing IP addresses.
Private channels: These are channels that are not announced to the network after creation, thus only the channel partners will include the channel in their network graphs. Private channels provide a slightly improved level of privacy for the counterparties of the private channel. If one should send a receiving invoice from a private channel the channel id will be revealed and this holds a lot of information that can link to the channel UTXOs and ultimately can be probed to figure out who the UTXOs belong to.
Privacy Concerns in lightning
There are still some privacy concerns while using the lightning network, and some of these concerns can also be mitigated on a per-user basis.
UTXO chain analysis: When opening a channel, previous transaction outputs are spent as inputs, One can then tell the source of funds used to create the channel, via chain analysis. There is also a good chance that the node that funded the channel can be deduced i.e the node can be linked to the UTXO which raises a privacy concern. A good way to mitigate this is not to open channels with UTXOs that are linked to personal identities.
Receiver Privacy: As you may have noticed in both public and private channels the receiver's information can be de-anonymized because they have to provide an invoice to receive payments. And this invoice can reveal UTXOs details
Balance Probing: In lightning, only the channel capacity is known i.e the total amount in the channel. In other to find out what part of the balance belongs to each node in a channel between Alice and Bob, an attacker can attempt to route fake payment requests through the channel using varying amounts. The attacker uses a fake payment hash that will never be fulfilled. Once Alice responds with a payment hash error, the attacker knows the probe was successful. The balance on Bob’s side of the channel is approximately the amount on the highest successful probe.
Potential Improvements To The Lightning Network
Taproot(https://bitcoinops.org/en/topics/taproot/): Taproot provides a way to make single and multi-signature transactions look similar. The use of Taproot in opening Lightning payment channels will make it harder to distinguish between them and other multi-sig transactions from regular single-signature transactions on-chain
Offers(https://bolt12.org/): Offers is a draft specification (called a "BOLT") for Lightning wallets and nodes. BOLT 12 introduces “offers” to the Lightning Network. This enables key functionality such as reusable QR codes, the ability to both send and receive payments with these offers, and of course enhanced privacy. An "offer" has enough information for you to reach out and fetch a real invoice from the vendor, through the Lightning Network itself, just like it would send a payment vendor, through the Lightning Network itself, just like it would send a payment
Rendezvous Routing Rendezvous Routing helps improve privacy by allowing a sender to hide the identity of the recipient from the rest of the network. When a sender initiates a transaction, they use a randomly generated, one-time-use payment hash to conceal the recipient's public key. The recipient can then use this hash to claim the payment, without revealing their identity.
This technique helps improve the privacy and security of transactions on the Lightning Network. By hiding the identities of both the sender and the recipient, they make it more difficult for attackers to track and manipulate transactions, and help ensure the confidentiality and anonymity of users on the network.
Conclusions
We can agree that lightning provides some sort of privacy but what is important to note is that this depends on how we use it and also varies for the receiver and sender.
So consider your privacy needs and act accordingly, for a sender, this might mean
When done, deplete your channel completely and close it out.
Do not receive or create invoices that reveal channel/UTXO info.
1 UTXO per node on a private channel.
For receivers, this might mean
Using Tor only and not using any sort of alias.
Never open a channel with a UTXO you own.
Do not share invoices publicly
Thanks to further research and Improvements in lightning security and privacy,
it will ultimately become easier to use lightning more privately.
References
https://lightning.network/lightning-network-paper.pdf
github.com/lnbook/lnbook