Blockchain security firm Bitslab points to one figure worth dwelling on: at least 11 of Liquid’s 15 functionaries put their signatures on the transaction. No key was stolen, in other words. Eleven separate signers reviewed the same withdrawal, and every one of them approved it.
What followed was an abnormal peg-out that pulled roughly $320 million in Bitcoin out of the Liquid Network’s federation reserve, and a sidechain that ground to a halt.
Bridge nodes were switched off by Liquid. SideSwap froze swaps along with peg-ins and peg-outs. As operators dug into what happened, exchanges either halted L-BTC deposits and withdrawals or got ready to.
Four thousand L-BTC that shouldn’t have existed
The sequence began Sept. 6, when a customer routed 4,000 L-BTC into SideSwap’s peg-out service — the mechanism that turns Bitcoin represented on Liquid back into BTC on the main chain.
According to SideSwap, the request passed through the standard authorization process, and roughly 3,996 BTC was released by the Liquid Federation. At the latest check, that Bitcoin had ended up at an address holding about 3,998.5 BTC.
The whole design rests on a straightforward guarantee: for every L-BTC in circulation, one BTC sits in the federation reserve. In a normal peg-out, the L-BTC is burned and an equivalent amount of Bitcoin is released.
The burn went through this time. The backing was never there to begin with. SideSwap said a software bug had minted L-BTC with no Bitcoin behind it, and those tokens nevertheless made it through a valid peg-out — at which point federation functionaries read the withdrawal as legitimate and released real BTC.
Blockstream traced the 4,000 L-BTC submitted for redemption back to a flaw in Elements, the software Liquid runs on, according to SideSwap. Should that account hold, the breakdown occurred before a single Bitcoin transaction was ever signed.
The keys worked exactly as designed
Neither Liquid nor SideSwap reports any theft of signing credentials. SideSwap’s valid Peg-out Authorization Key, or PAK, was used for the withdrawal, and Liquid stated that this key and the other federation keys were all uncompromised.
That sets this apart from the bridge hacks the industry has trained itself to recognize. Keeping keys secure counts for little when each signer is presented with the same invalid state and signs off on it.
As of the latest check, there was no public independent technical postmortem and no detailed description of a patch, which means the precise cause rests entirely on the accounts Liquid and SideSwap have given.
Negotiating in OP_RETURN messages
On-chain, the parties sitting on the Bitcoin described themselves as “whitehats” and said their intention was to hand back most of the funds once the underlying bug had been fixed across the network. Their channel to Blockstream has been Bitcoin transactions carrying OP_RETURN messages.
Alex Thorn, head of research at Galaxy Digital, said the opening message came from Blockstream, asking the holder to get in touch with its security team. The response: it planned to return “most” of the Bitcoin to the federation.
A subsequent message added a string. Blockstream fixes the bug and confirms that every node has been patched — then the funds come back.
The financial damage, then, may turn out to be modest. What remains unresolved is how nearly 4,000 BTC walked out of the federation with no apparent key compromise.
Patching is the easy half
Liquid’s job now is to locate and repair the Elements flaw, ship that fix to the affected nodes, and then demonstrate that a second batch of invalid L-BTC cannot follow the same route through authorization.
The books need balancing too. The L-BTC allegedly created by the bug was burned on its way out, but roughly 3,996 genuine BTC left the federation wallet and has yet to return.
Until that money comes back or the accounting is made whole another way, holders of legitimate L-BTC are still owed proof from Liquid that their tokens carry one-for-one backing. For as long as that work goes on, the bridge nodes remain disabled.