We know that one of the key characteristics of blockchain technology is privacy — all blockchains are built with this function in mind. Unlike traditional systems where intermediaries have full access to personal data and transaction details, blockchain uses cryptographic methods to protect sensitive user information while maintaining the transparency of the network itself. Transparency is achieved through decentralization: data and records are immutable and can be viewed simultaneously by all participants with authorized access.
At the same time, there is a separate category of digital assets, the so-called private (or anonymous) cryptocurrencies. These use additional technologies beyond the basic ones that increase privacy.
In this case, how is the balance between transparency and privacy maintained in cryptocurrencies? What is the application of private cryptocurrencies in real life?
Let’s understand in this article.
Privacy in the blockchain: myth or reality
Since the advent of bitcoin, cryptocurrencies have been shrouded in a halo of mystery. Due to the fact that the first digital coins were associated with illegal activities and transactions on the darknet, it was believed that they were completely anonymous and literally created for activities that required strict secrecy. However, this is not entirely true.
By and large, most cryptocurrencies are more “pseudonymous” than “anonymous”. After all, through transactions with them, thanks to the transparency of the blockchain, it is possible to somehow identify the person performing the actions. Transactions can be traced and associated with a specific wallet. There are ways in which law enforcement can track down the owners of wallets, and sometimes they are very successful in doing so. That is, we can not say that a transaction with a regular cryptocurrency is completely anonymous, because it is signed with a certain set of characters (pseudonym), with the help of which it is possible to identify the identity of the owner.
At the same time, there are a number of coins on the market that are able to provide complete anonymity of transactions.
What are private cryptocurrencies and how do they work?
In fact, the very concept of cryptocurrencies was born out of the vision that personal data protection and privacy are of paramount importance in the digital age. An informal community of cryptographers, programmers, and other activists promoted this idea in the 1980s. However, after the emergence of bitcoin in 2009, and as the crypto industry’s ties to traditional systems and the global Internet have strengthened, it has become clear that experts at a certain level can de-anonymize virtually any user if necessary. This becomes possible when the targeted user passes KYC on a stock exchange, links a wallet address to a bank card, provides his public key in correspondence, or performs some other “outward” action. Again, questions arose about how to ensure privacy in crypto transactions.
The idea of increasing privacy remained relevant, and in 2012 the first CryptoNote protocol appeared, on the basis of which a whole generation of coins with increased privacy was created.
The interest of users and developers is still strong today — at the time of writing, according to CoinGecko, there are 59 private cryptocurrencies on the market, and the capitalization of the private coins category is more than $6 billion.
The main goal of private cryptocurrencies is to provide a level of privacy where their owners become untraceable and elusive anonymizers. Unlike the pseudo-anonymity offered by traditional cryptocurrencies, private coins offer enhanced privacy provided by the most advanced cryptographic methods.
Its basic features are:
- Anonymity. These are based on making it difficult to associate a particular transaction with a particular person.
- Untraceability. This is its fundamental paradox: despite the transparent nature of the blockchain, the trace of a transaction is hidden when it is executed.
Advantages and Risks of Anonymous Transactions
Advantages
- High degree of privacy and anonymity.
- Positive role of private cryptocurrencies in ensuring financial freedom.
Disadvantages
- Bans or restrictions on the use of private currencies in some countries due to their frequent use in illegal activities.
- Technical difficulties in integrating with smart contracts that require transparency. Private cryptocurrencies may conflict with decentralized applications (dApps).
- Low liquidity compared to traditional cryptocurrencies. Confidential coins may be denied listing on exchanges with strict KYC and AML requirements.
- Slow speed and high transaction costs. Complex cryptographic methods require significant computing resources.
Technologies that enable anonymity on the blockchain
Today, cryptocurrencies that solve privacy issues use a variety of technologies. Before choosing a private cryptocurrency to invest in, it’s worth exploring the methods by which anonymous coins achieve enhanced privacy. Read reviews of Ring Signature, zk-SNARKs, zk-STARKs, and other technologies to see which one can accomplish the task at hand as efficiently as possible.
Let’s take a quick look at some of them:
Zero-knowledge-proofs (zKP, zk-SNARK, and zk-STARK)
This method allows verifying the correctness of a transaction and its compliance with protocol rules without revealing details of the transaction itself, such as sender/recipient addresses and amounts. Its weakness is the need for a computationally intensive process and trusted setup. Its strength is its great potential for scalability.
Ring signatures
This solution is less complex in implementation and weaker in reliability guarantees compared to ZKP-based tools. Its essence is to hide the signatures of the initiators of certain transactions by using a ring structure of signatures. That is, the task of ring signatures is to mix the signature of a particular sender with other potential senders. The more signatures involved, the greater the privacy of the address.
Stealth addresses
This method is also used to hide the address, but for the recipient. Here, the technology generates a unique, one-time address for each new transaction, making it impossible to link multiple transactions to the same recipient address.
Mixers
This technology is used to hide the origin and destination of funds — it combines multiple transactions into one at a neutral new address and then redistributes the coins to the recipients.
Private Cryptocurrency Comparison: Monero, Zcash, Dash
Monero (XMR)
Monero is the leader of the private coin segment, both in terms of capitalization and the set of features that ensure complete anonymity. A few years ago, the U.S. Internal Revenue Service (IRS) even promised to pay $625,000 to anyone who could crack it.
The cryptocurrency was released in 2014 and immediately proved to be the most secure, anonymous, and untraceable cryptocurrency. It offered almost total privacy, covering all possible scenarios.
Monero uses the PoW algorithm and has unlimited issuance. Monero’s privacy power set consists of hidden and ring addresses and RingCT. The coin hides sender/recipient addresses and transaction amounts using range proofs without revealing the exact values.
Zcash (ZEC)
Launched in 2016, Zcash is also a fork of bitcoin. Zcash uses zk-SNARK technology, which protects sender/recipient addresses and amounts. The user can choose to use this functionality or not. This makes Zcash different from Monero, where privacy is mandatory by default.
Dash (DASH)
Dash was launched in 2014. This anonymous coin runs on a hybrid algorithmic model that combines PoW with PoS and, like Zcash, offers enhanced anonymity as an option. This is achieved through the use of PrivateSend functionality based on blending technology. The two-tiered algorithm and InstaSend feature allow Dash to conduct instant transactions that are confirmed within a few seconds. In terms of anonymity, Monero offers better guarantees, but Dash is much faster and cheaper.
What regulators say
It is clear that regulators are more than suspicious of private cryptocurrencies as they contradict all regulations aimed at combating the shadow economy, money laundering, terrorism and organized crime.
As a result, some jurisdictions have banned the listing of private coins or tightened AML/KYC requirements for projects providing services related to private coins.
Regarding the regulation of private cryptocurrencies in different countries — in Japan they are completely banned, in South Korea and Australia they cannot be traded on exchanges. The U.S., on the other hand, has not banned their circulation, but has taken enforcement action against anonymous coin mixers (Tornado Cash). The MiCA regulations in the European uniоn inсlude certain requirements for private coins that are being discussed and finalized in order to achieve a balance between “privacy and security” in cryptocurrencies and to provide an optimal vector for the impact of private cryptocurrencies on the financial industry.
Currently, private cryptocurrencies are subject to anti-money laundering regulation by national governments under the guidelines updated by the FATF in 2022.
In fact, the dark side of private currencies gives regulators reason to be concerned. And when you consider all the myths and facts about private cryptocurrencies and ask yourself how anonymous transactions affect the reputation of the cryptocurrency market, the answer from public opinion experts is clear — bad. Despite the benefits to personal privacy, they pose huge problems for law enforcement.
Both Monero and Zcash are understandably active on the darknet and in fraudulent schemes. Because of their excellent privacy properties, they make it difficult to trace the financial chains of illegal activities: drug trafficking, tax evasion, fraud, and money laundering. Incidentally, the same cybercriminals who hack into blockchains are also exploiting the dark side of privacy coins by using mixers to cover their tracks.
So, the social and ethical aspects of anonymous transactions are an unresolved debate. On the one hand, private cryptocurrencies provide a sense of protection of personal boundaries, but on the other hand, they can be an aid to committing criminal acts. To be fair, it should be noted that private cryptocurrencies, the capitalization of which fluctuates around $6 billion — just a drop in the ocean of the shadow market, calculated in trillions. So, most likely, the future of private cryptocurrencies in the digital economy will depend on the ability of developers of anonymous coins to find the optimal balance in cooperation with regulators.
Thank you for your attention. Invest anonymously and safely!
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