Liquid Network halts operations after $320 million Bitcoin withdrawal

Liquid Network suspended its activity on Sunday after self-identified white hat hackers withdrew approximately 4,000 Bitcoin from its federation wallet. The withdrawn funds, valued at $320 million, represented about 95% of the network’s reported Bitcoin reserves at the time of the incident.

Large-Scale Withdrawal Disrupts Network Operations

The event, which took place on September 6, involved the federation wallet holding roughly 4,200 BTC before the unauthorized transaction. Liquid, a Bitcoin sidechain designed to facilitate fast and confidential asset transfers, had not confirmed the return of the funds as of its latest announcement.

A transaction associated with the incident included an on-chain message that stated, “We are whitehats. Contact us on chain.” Blockstream, the company responsible for developing the Liquid Network infrastructure, published a message on X indicating its efforts to communicate with the alleged white hat actors via a signed message on the Bitcoin blockchain. Details about these communications or the identities of those involved have not been disclosed.

Blockstream is working to contact the alleged white hats using an on-chain signed message, following the withdrawal of approximately 4,000 BTC from the Liquid Federation wallet.

Liquid asserted that the withdrawal was processed through the Peg-out Authorization Key (PAK) system but emphasized that neither the PAK key nor any other cryptographic keys were compromised in the breach.

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Impact on Network and Security Response

The PAK mechanism allows only registered accounts and designated Bitcoin addresses to complete peg-out transactions. Peg-out is a process where LBTC, the network’s token, is destroyed so that an equal amount of Bitcoin can be released from the federation wallet. Despite these safeguards, the network was forced to turn off its bridge nodes, effectively halting user transactions across the network.

Bridge nodes act as connectors between network participants’ nodes and the federation’s specialized servers. The suspension meant that users could no longer interact with the Liquid blockchain, and crypto exchanges were notified to stop deposits and withdrawals of LBTC, the network’s Bitcoin-pegged asset. Some exchanges immediately implemented these restrictions, while others indicated they would follow soon.

Liquid stated that tokens such as USDT and DePix, as well as fiat representations on the sidechain, were unaffected by the breach. However, users were warned of potential disruptions in wallet services until normal operations resume.

The sidechain will remain offline while federation members work to resolve the incident and restore services.

How the Liquid Network Works

The Liquid Network operates by allowing users to deposit Bitcoin into a federation-controlled wallet in exchange for receiving LBTC on the sidechain—a process known as peg-in. To convert back, users perform a peg-out, burning LBTC and releasing the equivalent Bitcoin from the reserve.

Blockstream’s documentation explains that 15 federation members, protected by hardware security modules, jointly control the reserve wallet. For Bitcoin to exit the reserve, at least 11 of these members must approve each peg-out transaction.

Liquid is built on Elements, an open-source platform based on the Bitcoin protocol but differing in that federation members, not miners, confirm blocks. Under normal circumstances, blocks are issued every minute.

In addition to LBTC, the Liquid Network supports a range of assets, including tokenized fiat currencies and securities. Its confidential transaction feature conceals transferred amounts and asset types from outside observers.

Founded in 2018, the Liquid Network aims to streamline asset exchange between participating brokers, exchanges, and traders. Launch participants included Bitfinex, OKCoin, BitMEX, and SIX Digital Exchange, and the network initially featured a two-minute settlement time for transactions.

Mini dictionary: Blockstream, a blockchain technology company founded in 2014, specializes in developing Bitcoin-related infrastructure and is responsible for building and maintaining the Liquid Network sidechain.