Privacy Coins Are Necessary If Crypto Is to Go Mainstream
Despite identifying wallets via alphanumeric (consisting of or using both letters and numerals) codes rather than real names, bitcoin isn’t anonymous. Because the blockchain keeps an immutable record of every single fraction of bitcoin moved in and out of these wallets, it's surprisingly easy to trace the flow of bitcoin from one wallet to another.
It's precisely for this reason that a new breed of cryptocurrencies – privacy coins – have been emerging since 2014. As the name implies, these aim to offer greater anonymity than the likes of bitcoin and ethereum. It's becoming apparent that privacy-coin features will be vital if cryptocurrencies are to be widely adopted in the future.
There are at least 30 privacy coins at the time of writing, with most of them aiming for privacy through a variety of different measures. The most well known is Monero (XMR), which was launched in April 2014 and which uses two methods to conceal identities: ring confidential transactions (RingCTs) and stealth addresses.
Simply put, the use of RingCTs allows the Monero blockchain to verify transactions without revealing how much was transacted and who transacting parties are. As for stealth addresses, these involve a recipient of a XMR payment receiving her new funds at a one-time, randomly generated 'stealth' address, which isn't linked to her usual account.
Such measures have helped to make Monero the 12th most valuable cryptocurrency – and the most valuable privacy coin – in the world. Its offer of anonymity has even won it the affections of North Korea, which has been mining the cryptocurrency in a bid to avoid the numerous economic sanctions issued against it.
This would suggest that privacy coins simply take the most 'controversial' features of cryptocurrencies and amplify them. Indeed, Pawel Kuskowski of the anti-money-laundering services company Coinfirm has even suggested that the anonymity of Monero paints all XMR tokens with the same tarnished brush.
"What we treat ‘high risk’ is something that’s anonymising funds,” he told Independent in January. “How are you going to prove that these funds are not coming from illegal sources?”
Yet it's precisely this inability to differentiate 'clean' from 'dirty' crypto tokens that makes a privacy coin like XMR so promising as a potentially mainstream digital currency. That's because it helps overcome the fungibility problem affecting bitcoin, saving tokens or wallets from being ‘blacklisted’ just because they’ve previously come into contact with bad actors.
However, Monero's privacy algorithm has a potential vulnerability that makes it possible for researchers to be able to trace around 80% of Monero transactions, a recent paper states.
Fungibility is something that other privacy coins strive for, but with mixed results. Zcash (ZEC) achieves privacy via a process known as “zk-SNARK” (zero-knowledge Succinct Non-Interactive Argument of Knowledge). Similar to RingCTs, this proves that a transaction is valid without recording any other information about it (such as amounts and addresses). However, Zcash's privacy feature is in fact optional, with only 3.6% of funds being held in z-addresses.
This undermines Zcash's claim to privacy and fungibility, since the vast majority of funds can be traced and linked to users. A similar complaint can be levelled against Dash (DASH), which was launched in 2014 and which offers privacy via CoinJoin.
This is a method that allows multiple payments to be made by multiple parties simultaneously, so that addresses are mixed together and become difficult to link with particular transactions. But once again, using CoinJoin is optional with Dash.
Another popular privacy coin that uses a different approach to anonymity but nonetheless encounters comparable problems is Verge (XVG). This anonymises users by hiding their IP addresses via the Tor network. The problem is, while this makes linking a particular wallet to a real-world identity more difficult, the fact that the blockchain and its transactions remain transparent still permits wallets to be identified – and valued – via careful detective work.
To be fair, Verge is in the process of introducing its own version of stealth wallets, yet once again these will be optional. That said, optionality may be a necessary ingredient if privacy coins such as XVG are to be widely adopted. As crypto developer and Verge contributor Eric Kryski noted in a recent blog post:
"There are certain cases where transactions need to be publicly verifiable by one or more third parties and other legitimate cases where they don’t."
For example, government and public bodies may require certain transactions to be verifiable in order to audit a company or ensure that certain regulations are being met, while businesses may require privacy so that suppliers, for instance, can't see what's the most they can afford to spend on new stock.
Coupled with the promise of complete fungibility, such features of privacy coins will be of paramount importance if any cryptocurrencies are to be used as currency on a mass scale. Even though some of the above coins have certain weak spots, they’re being improved constantly, while newer privacy coins (e.g. DeepOnion) are emerging all the time. And far from being an attempt by developers to make crypto even 'shadier' than it's sometimes perceived to be, privacy coins are, on the contrary, another important step in bringing crypto a bit closer to the mainstream.