In the age of tightening surveillance — which includes the digitization of banking and finance, which, in turn, allows governments to see or, worse, seize anybody’s funds at any time — cryptocurrencies came as a breath of fresh air. However, as you may well know, most cryptos — including Bitcoin — are not really anonymous but pseudonymous, which, combined with the innate transparency that comes with using the blockchain, can often cause the same shortcomings as traditional finance, allowing the funds and their movements to be tracked and sometimes tied to the user’s identity.
All of this led to the advent of the idea of privacy cryptocurrencies. Those are the coins that implement various methods of obscuring the movements of money and their movements’ history.
What Is A Privacy Cryptocurrency, And How Does It Differ From Other Cryptocurrencies?
How Are Traditional Cryptocurrencies Being Tracked?
By design, blockchain transactions are visible to all: through blockchain explorers, anyone can easily check the amounts of funds moved, as well as senders’ and recipients’ wallet addresses. Anonymity in this system comes from the fact that there are no data pertaining to the wallets in the explorers besides the addresses themselves. However, this system has its drawbacks, such as:
- Some large exchanges do require KYC, meaning that if you go through this procedure, the exchange now does have the information on your real identity alongside your wallet address;
- If you publish your wallet address — for example, to receive donations, payments for goods or services, etc. — you can deanonymize yourself;
- Same with giving your address privately or making payments: if your counterparty wishes, they can tie your wallet data to the identity information known to them.
Once the information about yourself has been tied to your wallet address, your transactions can be tracked through blockchain explorers, making it easy to see the money trail you’re leaving. This can be used by law enforcement and government agencies, scammers, or basically anyone else which by itself can be uncomfortable, especially for users who move large amounts of funds.
What’s Different About Privacy Coins?
Privacy cryptocurrencies utilize innovative technologies and protocols to obfuscate the origin, destination, and amount of transactions. These technologies are constantly evolving, and new privacy-focused cryptocurrencies may adopt different approaches to enhance privacy and protect user identities.
Each privacy coin employs its own combination of cryptographic techniques and protocols to achieve anonymity, so to explain the ways in which they differ from ordinary coins in more detail, we need to take a closer look at some of them, particularly at the top-3 2023 privacy coins by market capitalization, which are Monero, Dash and Zcash.
Monero is widely regarded as one of the leading privacy cryptocurrencies. It employs ring signatures, stealth addresses, and confidential transactions to obfuscate transaction details and provide enhanced privacy. Monero's robust privacy features have made it a preferred choice for users seeking anonymity in their transactions, and the XMR transaction volume far surpasses not only other privacy coins but many well-known crypto projects in general.
Monero uses a multi-pronged approach to keep the transactions as private as possible, without relying on any one feature.
- Firstly, it employs a technology called ring signatures. In a typical cryptocurrency transaction, the sender's public key is visible on the blockchain. However, with ring signatures, Monero mixes the sender's public key with several other public keys from the network, making it challenging to determine the actual sender.
- Additionally, Monero implements stealth addresses, which generate a unique one-time address for each transaction. This feature ensures that the recipient's identity remains hidden, as the address is not linked to their public key on the blockchain.
- Lastly, Monero utilizes confidential transactions, which obfuscate the transaction amount, making it difficult to determine the exact value being transferred.
Zcash is another prominent privacy coin that utilizes zero-knowledge proofs called zk-SNARKs (zero-knowledge succinct non-interactive arguments of knowledge). This technology allows for the verification of transactions without revealing the sender, receiver, or transaction amount. Zcash offers both transparent and shielded addresses, providing users with the option to make private or public transactions.
Zk-SNARKs allow for the verification of a transaction without revealing any of its details. In the case of Zcash, this means that the sender, recipient, and transaction amount can remain completely shielded. Zcash provides users with the option to choose between transparent and shielded transactions. Transparent transactions are similar to Bitcoin transactions and are visible on the blockchain, while shielded transactions leverage zk-SNARKs to ensure complete privacy.
While Dash is not solely focused on privacy, it offers a feature called PrivateSend that provides enhanced anonymity for transactions. PrivateSend utilizes a coin mixing mechanism to mix and anonymize funds, making it difficult to trace the flow of funds on the blockchain.
The mixing process involves breaking down the transaction into multiple inputs and outputs and then combining them with inputs and outputs from other users. This process makes it challenging to trace the flow of funds, enhancing privacy. Dash also utilizes a decentralized network of masternodes, which help facilitate the mixing process and add an extra layer of privacy and security to the network.
There are some other — smaller, but notable — privacy cryptocurrencies that we can look at, as they also have their place in this niche.
Verge aims to provide secure and anonymous transactions through several privacy-focused features. It employs Tor and I2P networks to hide the IP addresses of users, ensuring that transaction origins are obfuscated. Verge also offers optional stealth addressing and transaction obfuscation to enhance privacy.
Verge implements multiple privacy-centric technologies to achieve anonymity. It utilizes the Tor network, which anonymizes internet traffic, to hide the IP addresses of users. Verge also incorporates the I2P network, which is similar to Tor but specifically designed for peer-to-peer communication. By routing transactions through these networks, Verge conceals the origin and destination of transactions. Additionally, Verge offers optional stealth addressing, where unique addresses are generated for each transaction, preventing linkage between the sender and recipient.
Grin is an open-source privacy coin that aims to provide maximum privacy by default. It utilizes the Mimblewimble protocol, which combines transactions into a single, compact block without revealing the transaction details. With its focus on privacy and scalability, Grin has garnered attention within the cryptocurrency community.
Grin is built on the Mimblewimble protocol, which provides strong privacy and scalability. Mimblewimble combines multiple transactions into a single, compact block, obscuring the transaction details. The protocol uses confidential transactions to hide the transaction amounts and employs cut-through, which eliminates unnecessary data from the blockchain. By minimizing the information stored on the blockchain, Grin ensures greater privacy and scalability.
Beam is another privacy coin that implements the Mimblewimble protocol. It offers features like confidential transactions, where the transaction amounts are hidden, and transaction cut-through, which allows for the elimination of unnecessary data. Beam also enables users to have control over their transaction metadata, enhancing privacy.
Similar to Grin, Beam also utilizes the Mimblewimble protocol. Beam incorporates features such as confidential transactions, where the transaction amounts are hidden, and transaction cut-through, which reduces blockchain bloat. Beam also offers user-controlled transaction metadata, allowing users to choose what information they want to disclose. This feature gives users greater control over their privacy.
It's worth noting again that while these privacy cryptocurrencies provide advanced privacy features, they each have their own unique implementations and trade-offs. Users should conduct thorough research and understand the specific features, technology, and community behind each cryptocurrency before engaging with them.
Privacy Coins Use Cases
The question that’s often asked is what are the potential use cases for privacy cryptocurrencies? And privacy coins, indeed, offer several potential use cases due to their enhanced anonymity features. Here are some of the main ones:
Privacy cryptocurrencies allow individuals to have greater control over their financial information. They can use privacy coins to conduct transactions without exposing their personal identities or financial details to the public. This use case is particularly relevant in regions where financial privacy is highly valued or where individuals face potential risks if their financial activities are publicly known.
Privacy cryptocurrencies offer improved security by obfuscating transaction details and participant identities. This can be advantageous in situations where maintaining confidentiality is critical, such as for high-profile individuals, businesses, or organizations. Privacy coins can protect against identity theft, financial fraud, and other forms of malicious activities.
Protection against Surveillance
Privacy cryptocurrencies can provide individuals with a means to protect themselves against surveillance and data collection by government entities, corporations, or malicious actors. By using privacy coins, individuals can minimize the risk of their financial transactions being monitored and their spending habits being tracked.
Avoiding Censorship and Restrictions
In regions with strict capital controls or limitations on financial freedom, privacy cryptocurrencies can enable individuals to bypass restrictions and access financial services. By using privacy coins, individuals can transact without relying on traditional banking systems or facing censorship from authorities.
Micropayments and Online Privacy
Privacy cryptocurrencies can facilitate micropayments and protect users' privacy in online transactions. They offer a way to conduct small transactions without exposing personal details, making them suitable for online purchases, content subscriptions, donations, and other digital services where privacy is valued.
Privacy cryptocurrencies can provide a means for whistleblowers to protect their identities and financial transactions while reporting corruption, illegal activities, or misconduct. By using privacy coins, individuals can contribute information without fear of retaliation or identification.
Pros and Cons of the Privacy Coins
Privacy coins offer distinct advantages and disadvantages, as we already glimpsed. Mainly they can be boiled down to several points.
Pros of Privacy Coins
Enhanced Privacy and Anonymity
The primary advantage of privacy coins is their ability to provide increased privacy and anonymity for users. By obfuscating transaction details and concealing user identities, privacy coins offer a higher level of confidentiality compared to traditional cryptocurrencies. This is particularly beneficial for individuals concerned about their financial privacy or those operating in regions with strict financial surveillance.
Protection against Surveillance and Data Mining
Privacy coins mitigate the risks associated with surveillance and data mining. With the growing prevalence of data breaches and intrusive data collection practices, privacy coins offer users the ability to transact without leaving a digital trail that can be exploited or used for targeted advertising.
Privacy coins enhance fungibility, which refers to the interchangeability of one unit of currency with another. Since privacy coins obscure transaction histories, it becomes difficult to distinguish between individual coins, ensuring that they are all treated as equal. This is in contrast to traditional cryptocurrencies, where certain coins may be tainted due to their association with illicit activities and can bring problems down the line of the chain of owners (even people who are completely clean).
Privacy coins empower individuals with greater control over their financial transactions and personal information. Users can decide when and how to disclose their identities, ensuring that their financial activities remain confidential. This aligns with the principles of decentralization and user autonomy that underpin the cryptocurrency ecosystem.
Cons of Privacy Coins
The enhanced privacy features of privacy coins have attracted the attention of regulatory bodies and law enforcement agencies. The potential misuse of privacy coins for illicit activities such as money laundering, tax evasion, and funding criminal enterprises has raised concerns. As a result, some jurisdictions have implemented stricter regulations around privacy coins to strike a balance between privacy and security.
Stigmatization and Limited Acceptance
Privacy coins can face stigmatization due to their association with anonymous transactions and potential illicit use. This can lead to limited acceptance and adoption by businesses and exchanges that may be wary of the regulatory implications. Consequently, it may be more challenging to use privacy coins for mainstream transactions compared to widely accepted cryptocurrencies like Bitcoin or Ethereum.
While privacy coins offer privacy benefits, they can also hinder transparency. By obscuring transaction details, privacy coins make it difficult to track and audit transactions, which can be a concern for organizations and individuals who prioritize financial transparency or require public accountability.
The advanced cryptographic techniques used by privacy coins can introduce technical complexities. Users need to have a solid understanding of the privacy features, such as ring signatures, zk-SNARKs, or Mimblewimble, to utilize these coins effectively. This can pose a barrier to entry for individuals who are less technically inclined or unfamiliar with these concepts.
As with any technological innovation, privacy coins come with their own set of advantages and disadvantages. It is crucial for users to carefully consider these factors and assess their individual needs before deciding to engage with privacy-focused cryptocurrencies.
Are There Regulatory Concerns About Privacy Coins?
In the "Cons" section we mentioned regulatory scrutiny, and yes: regulators around the world have long been concerned about privacy coins. No wonder: those coins attract a wide variety of people who are averse to government control, which is the opposite of what the regulatory agencies want. Let’s look at some of the more popular concerns in more detail — to give you an idea of what kinds of obstacles private cryptos can face in the future.
Anti-Money Laundering (AML) and Know Your Customer (KYC)
Privacy cryptocurrencies can make it difficult to trace transactions and identify the parties involved. This raises concerns about their potential for facilitating money laundering, terrorist financing, and other illicit activities. Regulators are concerned about the lack of transparency and the ability to comply with AML and KYC regulations when privacy features are built into cryptocurrencies.
Many jurisdictions have introduced regulations to combat money laundering and terrorist financing, such as the Financial Action Task Force (FATF) guidelines. Privacy cryptocurrencies that provide strong anonymity features may make it challenging for cryptocurrency exchanges and other financial institutions to comply with these regulations. Regulators worry that these privacy features could hinder the ability to monitor and report suspicious transactions effectively.
Law Enforcement and Investigation
Privacy cryptocurrencies can impede law enforcement agencies' ability to investigate and track criminal activities. Cryptocurrency transactions are typically recorded on public blockchains, allowing for traceability. However, privacy cryptocurrencies use various techniques, such as ring signatures, zero-knowledge proofs, and stealth addresses, to obscure transaction details and participant identities. This makes it challenging for authorities to gather evidence and hold individuals accountable for illegal activities.
Anonymity provided by privacy cryptocurrencies raises concerns about tax evasion. When transaction details are obscured, it becomes difficult for tax authorities to track and verify cryptocurrency transactions accurately. This can lead to challenges in enforcing tax regulations and ensuring individuals and businesses fulfill their tax obligations.
Privacy cryptocurrencies may pose risks to consumer protection. The enhanced privacy features could facilitate scams, fraud, and other malicious activities without easy recourse for victims. Regulators are concerned about the potential lack of accountability and the challenges associated with recovering funds in the event of fraudulent transactions.
Central Bank Control
Privacy cryptocurrencies that gain significant adoption could potentially undermine central banks' ability to implement monetary policies and regulate the financial system. These currencies operate independently of traditional banking systems, making it difficult for central banks to monitor and control the flow of money, impacting their ability to manage inflation, stabilize the economy, and prevent financial crises.
Regulatory bodies worldwide are closely monitoring the development and usage of privacy cryptocurrencies. Some jurisdictions have implemented stricter regulations around these cryptocurrencies, requiring exchanges to follow stricter AML and KYC procedures or even imposing outright bans on their use. The balance between privacy and regulatory concerns remains a significant challenge, as regulators aim to address illicit activities while respecting individuals' legitimate privacy rights.
To summarize, privacy cryptocurrency, also known as an anonymous cryptocurrency, is a type of digital currency that emphasizes and prioritizes the privacy and anonymity of its users. It is designed to protect the identities and transaction details of its participants by employing various advanced cryptographic techniques.
One of the key features that distinguish privacy cryptocurrencies from other cryptocurrencies is the focus on concealing user identities. While most traditional cryptocurrencies, such as Bitcoin and Ethereum, record transactions on public ledgers, privacy cryptocurrencies utilize innovative protocols to obfuscate the origin, destination, and amount of the transactions. By doing so, they aim to provide users with a higher level of privacy and protect them from surveillance, data mining, and other forms of intrusive analysis.
Privacy cryptocurrencies employ several mechanisms to achieve anonymity. One common technique is ring signatures, which mix the transaction inputs and outputs with those of other participants, making it difficult to trace a specific transaction back to an individual. Another method is stealth addresses, which generate a unique address for each transaction, ensuring that the receiver's identity remains hidden. Additionally, some privacy cryptocurrencies utilize zero-knowledge proofs, allowing for the verification of transactions without revealing any sensitive information.
In contrast to traditional cryptocurrencies, privacy-focused digital currencies prioritize confidentiality and shield the identities of their users. They recognize the growing concerns regarding privacy in an increasingly interconnected and surveilled world. By providing an extra layer of security and anonymity, privacy cryptocurrencies offer users the freedom to transact without the fear of their personal information being exposed or exploited.
However, it is important to note that while privacy cryptocurrencies aim to enhance anonymity, they can also attract illicit activities. Their privacy features have raised concerns among regulators and law enforcement agencies who worry about the potential misuse of these cryptocurrencies for money laundering, tax evasion, and other illegal purposes. As a result, some countries have implemented regulations and requirements to address these concerns while still acknowledging the need for privacy in the digital realm.