Cheerleaders for cryptocurrencies often point to the privacy that transacting with digital coins can bring. But for some people even that is not enough. For those wanting to transact completely anonymously, there are anonymity-enhanced cryptocurrencies – typically known as privacy coins. While they use blockchain technology to record transactions in the same way as other coins, cryptographic techniques are employed to disguise user balances and personal details.
That sounds useful, considering that the European Commission is hoping to have new rules governing crypto transactions in place by 2024 and other jurisdictions are set to follow suit. But investors who have turned to privacy coins in recent months have not generally fared well.
There are plenty of recent developments that privacy enthusiasts can point to in support of their suspicions. According to someone going by the name of Harlequin – a developer at Haven Protocol, which describes itself as a network of private stable assets – anything from protesting Canadian truckers having their bank accounts frozen to the weaponization of the Swift global payments system against Russia have raised awareness of the need for financial privacy.
The threat of exclusion is what gives regulators the necessary leverage to ensure their rules are complied with
Ryan Shea, Trakx
“The freezing of crypto accounts has made the need for censorship-resistant money even greater, especially in countries where governments have taken a more heavy-handed approach to regulation or even the outright banning of crypto,” says Harlequin.
For the moment, however, that privacy is coming at a steep cost. Data from CoinMarketCap shows that Zcash, the second-largest privacy coin by market capitalization, fell from a high of just over $115 in mid-May to $50 by the middle of July. At the time of writing, it was trading at just under $79.
The biggest privacy coin, Monero, also dropped sharply, from $207 at the end of May to $98 just three weeks later, before rallying to the current level of $167.
Why should this be? According to Ryan Shea, a crypto economist at trading platform Trakx, privacy coins have simply been dragged down in lock-step with other cryptocurrencies by ongoing worries about a global economic downturn and the negativity around crypto following the collapse of Terra.
Many crypto users have also been deterred by the difficulty of converting privacy coins into fiat currency and back again, a process that uses what are often described as on-ramps (buying crypto) and off-ramps (buying fiat).
The problem is the privacy. Governments tend not to like the idea of being able to conduct transactions without providing any personally identifiable information or transaction details. They worry that people will do nefarious things with that ability. As a result, many major crypto exchanges – including Trakx – do not list privacy coins.
“This is especially important for those providing on/off-ramp capabilities because they require access to the traditional financial sector,” says Shea. “The threat of exclusion is what gives regulators the necessary leverage to ensure their rules are complied with. The end result is that converting privacy coins into fiat currency is more of a challenge because there are fewer trading platforms where such transactions can be made.”
Transaction shielding
Harlequin claims the technology used to facilitate conversion to fiat currency is rapidly developing, but acknowledges that there are still additional hoops to jump through. “However, projects such as THORChain are building cross-chain swaps and will be including privacy coins to allow greater flexibility in their use,” he adds. “And other platforms are also making progress in terms of making swaps easier to manage.”
A further complicating factor for potential privacy coin users is that not all coins are structured in the same way. Monero is cryptographically private by default and its privacy features cannot be turned on or off by the user, whereas Zcash has functionality that enables users to disclose transaction data if they wish. Monero also utilizes ‘stealth’ addresses – randomly created addresses for each transaction – to protect the privacy of the recipient.
It is best to back privacy tokens whose fundamentals are broader than just transaction shielding, since regulators are typically onto these kinds of coins
Adam O’Neill, Bitrue
Another technique employed by Monero is ring signatures. Typically, when a crypto holder signs a transaction with a private key, their signature can be traced to their address. But by including multiple signatures in the same transaction, this type of tracking becomes much harder.
Zcash uses something else to ensure privacy – zero-knowledge proofs, or ‘zero-knowledge succinct non-interactive arguments of knowledge’ in full, a cumbersome description whose purpose seems to be to provide an appropriately trolling acronym of ‘zk-Snarks’.
“This technology allows users to confirm that they have the correct information but without having to disclose details of the sender, receiver or amount,” says Shea. “It means that transactions can be confirmed as having met the required conditions without any information being exposed.”
Another differentiator is the structure of the organization behind the two largest privacy coins. Monero is a decentralized community project whose leadership team largely operates under aliases, whereas Zcash is run by the Electric Coin Company and has considerable academic backing.
“Investors who want to buy a privacy coin need to understand the core fundamentals behind the token,” said Adam O’Neill, chief marketing officer of exchange Bitrue. “It is best to back privacy tokens whose fundamentals are broader than just transaction shielding, since regulators are typically onto these kinds of coins.”
