Depending on which lawyer you ask, it might be perfectly legal or a crime to operate a Bitcoin Lightning node. But this area of the law has nothing to do with securities or the SEC. Rather, Bitcoin’s Lightning Network may be subject to 18 U.S. Code § 1960, the Prohibition of Unlicensed Money Transmitting Businesses.
Bitcoin is a commodity, so operators of regular Bitcoin nodes — which don’t earn fees for validating transactions — aren’t subject to the jurisdiction of the US Securities and Exchange Commission (SEC).
Instead, the US Commodity Futures Trading Commission (CFTC) oversees any trading of Bitcoin futures or derivatives. Sure, the SEC regulates any securitized products involving bitcoin, such as mining companies and ETFs, but otherwise leaves the network alone.
In contrast to Bitcoin nodes, however, the Lightning Network uses entirely different software. Importantly, most Lightning node operators earn fees for routing transactions. This makes their labor quite distinct from the voluntary, unpaid labor of regular Bitcoin nodes.
For context, the Lightning Network is a mesh network of users sending and receiving bitcoin off-blockchain via ‘bar tab’-like payment channels. With just one opening and closing transaction on Bitcoin’s regular blockchain, Lightning network users can route unlimited bitcoin through Lightning nodes within seconds and for minimal cost. Lightning sacrifices Bitcoin’s absolute security and decentralization for the cheap, fast convenience for this experience.
The crime of unlicensed money transmission
According to US law, it’s a crime punishable by up to five years in prison to knowingly control or manage an unlicensed money transmitting business. A money transmitting business ‘affects interstate or foreign commerce… by transferring funds on behalf of the public by any and all means.’
This includes any person who, without a license, ‘engages as a business in the transmission of currency, funds, or value that substitutes for currency, including any person who engages as a business in an informal money transfer system or any network of people who engage as a business in facilitating the transfer of money domestically or internationally outside of the conventional financial institutions system.’
There are a few key phrases in that definition, such as ‘business’ and ‘on behalf of the public.’ However, the final sentence is frighteningly clear.
For Bitcoin Lightning node operators, however, it’s not a great definition.
Lightning node operators seemingly engage with one another as a business. Legally defined, a business is ‘an enterprise that is carried on for profit or financial gain.’ Lightning routing node operators connect to one another in order to facilitate the movement of bitcoin for a fee.
They also seemingly transfer money ‘outside of the conventional financial institutions system.’
So, are Lightning node operators illegal money transmitters? Is operating a routing node a federal crime?
Disagreement on whether Lightning nodes are illegal
Well, lawyers disagree on a couple of words here. Specifically, most lawyers disagree on the legal intent of ‘business’ and ‘money.’
It’s unclear whether Lightning node operators, even when coordinating with one another to profitably route payments, are meaningfully a ‘business’ as Congress intended.
Similarly, it’s unclear whether Congress intended ‘money’ to encompass bitcoin, which possesses some characteristics of money — store of value, medium of exchange, standard of value, unit of account, etc. — but has more historical volatility than most conventional currencies.
Another important phrase is ‘on behalf of the public.’ Is the Lightning network really a public service, or more a niche for enthusiasts?
Read more: LND Onion Bomb: Another Lightning Network bug put users’ bitcoin at risk
Must money transmitters control funds?
Lastly, many lawyers disagree on a contentious quality of money transmission: control of funds. According to many pro-crypto lawyers and even a couple of senators, money transmitters must have control of funds in order to engage in the business of transmitting funds on behalf of the public.
If true, this would probably exempt Lightning routing nodes from the licensing requirements of money transmission, as Lightning nodes never possess nor control bitcoin (except the one-way control to route a payment along a user-specified path).
However, the US Justice Department (DoJ) wholeheartedly disagrees that the law requires money transmitters to control funds. In a court filing, the DoJ explained its view: “That ‘control’ is a prerequisite for any money transmitting business is legally baseless, contrary to the plain text of the statute.”
The DoJ continued, “Under the ordinary meaning of the word ‘transfer,’ there is no requirement that the transferer exercise control over the funds being transferred… If Congress had intended that control of the funds was a requirement, it could have said as much in the plain text of the statute. It did not.”
Disagreement between pro-crypto lawyers and the DoJ on the control of funds aspect of money transmission continues today. The DoJ is actively litigating criminal counts against defendants like the Tornado Cash and Samourai co-founders that depend on Congress not intending to include control of funds in money transmission statutes. The outcome of this disagreement will certainly be fascinating.
No legal clarity for Bitcoin’s Lightning Network
In any case, it’s unfortunate for fans of Bitcoin’s Lightning Network that users don’t have legal clarity. Ask a dozen lawyers whether a Lightning routing node operator is a member of an illegal money transmitting business, and you will receive a dozen nuanced responses, occasionally in opposition to other counsel.
Unlike Bitcoin’s commodity blockchain and network of volunteer nodes, the Lightning Network’s fee-earning routers might have a different legal classification.
