CryptoSlate
Liquid Network was effectively halted after nearly $320 million in Bitcoin exited its federation reserve through an abnormal peg-out on Sept. 6. A customer submitted 4,000 L-BTC to SideSwap's peg-out service, the routine mechanism that converts Liquid-represented Bitcoin back into BTC on the main network. SideSwap said the request passed normal authorization and prompted the Liquid Federation to release about 3,996 BTC. Liquid disabled its bridge nodes after the withdrawal, while SideSwap suspended swaps, peg-ins, and peg-outs. Multiple exchanges paused or prepared to pause L-BTC deposits and withdrawals.
Why it matters
The actors controlling the Bitcoin identified themselves through on-chain messages as whitehats and said they intended to return most of the funds once the underlying bug was fixed across the network. SideSwap and Blockstream traced the 4,000 L-BTC presented for redemption to a flaw in Elements, the software underlying Liquid. If confirmed, the bug created L-BTC without corresponding Bitcoin backing, then those tokens nevertheless entered a valid peg-out process that 11 of Liquid's 15 functionaries signed. Liquid said neither the Peg-out Authorization Key nor other federation keys were compromised, which is what makes this a different category of failure from a conventional bridge exploit: every signer was presented with the same invalid state and accepted it as legitimate.
Market impact
The whitehats later responded via OP_RETURN messages that Blockstream should fix the bug first and ensure every node is patched before the funds are returned. The allegedly bug-created L-BTC was burned during the peg-out, but about 3,996 real BTC still left Liquid's federation wallet, so the network still has to demonstrate that legitimate outstanding L-BTC remains backed one-for-one until those funds return or the accounting is otherwise restored. Bridge nodes remain disabled while remediation continues. The financial loss may ultimately be limited, but the harder task is proving the same authorization process cannot repeat the mistake.
Frequently asked questions
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What happened to Liquid Network on Sept. 6?
About $320M in Bitcoin exited Liquid's federation reserve through an abnormal peg-out. Liquid disabled its bridge nodes, SideSwap suspended swaps, peg-ins, and peg-outs, and exchanges paused L-BTC deposits and withdrawals.
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How did the attackers drain nearly 4,000 BTC without stealing federation keys?
SideSwap and Blockstream traced the 4,000 L-BTC presented for redemption to a flaw in Elements, the software underlying Liquid. The bug created L-BTC without corresponding Bitcoin backing, and 11 of 15 federation functionaries signed the peg-out as legitimate.
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Who is holding the drained Bitcoin?
The actors controlling the funds identified themselves through on-chain messages as whitehats and said they intend to return most of the Bitcoin once the underlying bug is fixed across the network.
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What must Blockstream and Liquid do before the funds are returned?
Per the whitehats' OP_RETURN messages, Blockstream must fix the Elements bug and ensure every affected node is patched before the funds are returned. Liquid must also reconcile its reserve so legitimate outstanding L-BTC remains backed one-for-one.
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Is Liquid's Bitcoin reserve still fully backed?
The allegedly bug-created L-BTC was burned during the peg-out, but about 3,996 real BTC still left the federation wallet. Until those funds return or the accounting is otherwise restored, Liquid has to demonstrate that outstanding L-BTC remains backed one-for-one.
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