One of the strong selling points of cryptocurrency is the degree of anonymity it provides. However, many crypto enthusiasts feel that many popular cryptocurrencies like Bitcoin lack true privacy.
Privacy coins are specifically designed to add a layer of privacy to the benefits and functionality of cryptocurrency.
What Are Privacy Coins?
A privacy cryptocurrency coin obfuscates information about its users, including identities and other transactional information.
Contrary to popular belief, the popular cryptocurrency Bitcoin isn’t anonymous– it’s actually one of the most transparent ways to send money since all transactional records are stored in the blockchain.
People won’t be able to see your name (i.e., Jack Johnson), but they can see your public address– it doesn’t take much to pair an identity to a public key, especially if you have the resources of an organization such as the FBI or DEA. Many cryptocurrency exchanges require their users to go through KYC/AML to explicitly define their identities before using the exchange.
If someone identifies the person behind one Bitcoin transaction, they also know who is behind all other transactions from that address. Those interested could also connect the nodes in the Bitcoin network to track transactions. This is easy to figure out, thanks to the public ledger.
For example, Satoshi Nakamoto’s (the creator of Bitcoin) Bitcoin address has been publicly visible since its inception.
Enter privacy coins. Privacy coins hide any information that can link an individual to a transaction. While all privacy coins aim to provide this level of privacy, some vary in their degree of anonymity. Many hide the size of cryptocurrency transactions or the amount of cryptocurrency you hold.
Why Aren’t Cryptocurrencies Private?
It’s simple to figure out the parties of a completed transaction based on a Bitcoin address, but it takes time. Bitcoin and other cryptocurrencies pride themselves on transparency, which allows for trust in the system.
Simply put, privacy coins sacrifice transparency in favor of privacy.
How Privacy Coins Deliver Privacy
Privacy coins typically provide privacy in one of two ways. Those that focus on anonymity hide the identities of people behind transactions. Those that focus on untraceability prevent people or computer systems from following a transaction trail.
Privacy coins typically rely on one of several main strategies to achieve either of these two goals.
CoinJoin or Coin Mixers
One very popular option for cryptocurrency anonymity is coin mixers or CoinJoin. This isn’t a particular coin, per se, but more of a program that combines multiple transactions to create a single transaction.
Then, it divides that single transaction up to send the relevant amounts to each recipient. In other words, the cryptocurrency that each recipient gets will be from a combination of senders instead of a single one.
Coin mixers aren’t exactly fully anonymous. They’re just more cumbersome to disentangle.
Ring addresses connect various wallet addresses, so it is not clear which of them sent or received the transaction. Monero is among the major privacy coins that use this technique.
Privacy coins that use stealth addresses create new addresses for every single cryptocurrency transaction.
One of the most popular examples of this is Monero (XMR). Monero relies on the dual-key stealth address protocol, a specific type of stealth address.
A system called Zero-Knowledge Succinct Non-Interactive Argument of Knowledge (zk-SNARK) lets the blockchain prove the validity of transactions without identifying the parties or balances, hence the “zero-knowledge” portion of the name.
Who Uses Privacy Coins?
The popular criticism of privacy coins is that they are appealing tools for criminals. Critics argue that privacy coins make it easy to finance terrorism, launder money, or manage finances for other illegal activities, with limited to no potential repercussions.
However, advocates for privacy coins simply want transactional privacy. There are plenty of reasons someone simply wants to keep their transactions private, such as hiding their wealth, so cyber-criminals don’t attempt to target them, or that they simply don’t want to divulge how they spend their money.
Private Coins and Regulation
Privacy coin laws vary by country, as with any other cryptocurrency. Some outright ban them, while others leave them in a legal gray area.
South Korea and Japan, for example, have decided to make the use and possession of privacy coins illegal.
In the United States, privacy coins are technically legal, but regulatory agencies have been working on methods to exploit information kept in the dark.
However, if you’re trying to buy privacy coins on popular U.S.-based exchanges like Coinbase, you’ll find yourself in dire straits. In working with regulators, many exchanges have been urged to delist anonymity and privacy coins like Monero and Zcash from their exchanges.
Many coins like Monero can be mined using similar methods to Bitcoin mining. The legal risk, although non-explicit today, however, is entirely on the miner.
Privacy Coin Exchange Availability
While private coins aren’t explicitly outlawed, their availability is limited.
Guidelines like AML (Anti-Money-Laundering), CFT (Combating the Financing of Terrorism), and KYC (Know Your Customer) obligations require cryptocurrency exchanges to collect certain information on their clients, which isn’t always possible with privacy coins.
To avoid being slapped with fines, fees, and outright bans by regulators, exchanges simply choose not to list the privacy coin.
The Financial Action Task Force (FATF) guidelines, updated in June 2021, include new AML/CFT guidelines, including new AML/CFT recommendations. To avoid legal issues, many exchanges chose to stop listing privacy coins.
That’s why you won’t find some of the biggest privacy coins, like Monero, Dash, and Zcash, on Coinbase or Bittrex.
The Most Popular Privacy Coins
To better illustrate privacy coins, let’s explore some popular privacy coins.
Beam uses the Mimblewimble (MW) protocol, which eliminates the need for any address. It makes private transactions the default.
Dash is a fork from the Bitcoin chain that relies on the CoinJoin method. Dash gives users the option of whether they want your transaction to be public or private.
InstantSend, another unique feature of Dash, will send and confirm transactions within two seconds.
Monero has the biggest market cap of its privacy coin ilk. It launched in 2014 as a Bytecoin fork.
Monero relies on stealth addresses and ring signatures to hide everything from the addresses of the sender and recipient to the full transaction amount.
So, in theory, one could send $1,000,000 in Monero across the world in under 30 minutes for a measly transaction fee of under $20, and no one would be able to discern who sent how much and to how.
Verge is an open-source project maintained by volunteers. It aims for privacy via I2P and TOR, the first of which encrypts data. After encryption, TOR sends the communications to a volunteer-run distributed network. This combination completely hides IP addresses for untraceable transactions.
Verge originally launched as DogeCoinDark as an anonymous version of Dogecoin but rebranded in 2016.
Zcash relies on the zk-SNARKs protocol to hide personal and confidential data, such as cryptocurrency addresses and the amount in a transaction.
One unique characteristic about Zcash is that it not only offers fully private transactions, but it also offers fully public transactions and the ability to make some aspects of a transaction public and some private. This makes it more friendly to regulators than other options, as regulators prefer public transactions.
Zcash has the unique option of letting senders include private memos in fully shielded transactions.
Final Thoughts: What’s the Deal with Privacy Coins?
When you use a regular cryptocurrency like Bitcoin, your transactions aren’t completely private. Given enough time, a computer program or person could link your identity to your wallet address and find out how much cryptocurrency you hold based on public ledger information.
While cryptocurrencies like Bitcoin advocate for decentralization, privacy coins add another layer of anonymity.
This feature has created mixed sentiments both within and outside of the cryptocurrency industry. Since privacy coins are harder to regulate, and cryptocurrency advocates tend to push for a gentle hand with government regulators, many within the community have attempted to sway the image away from anonymous coins.
To that end, many outside of the cryptocurrency industry wrongfully attribute the potential negatives that can come with privacy coins (funding illicit transactions, etc.) to coins like Bitcoin, which is arguably more transparent than the U.S. Dollar.
Privacy coins are financial history in motion and are a chapter worth following.