Blockchain technology has been a crucible for groundbreaking innovations that are redefining the financial, artistic, and entertainment spaces.
Decentralized finance (DeFi), non-fungible tokens (NFTs), decentralized applications (dApps), GameFi, decentralized autonomous organizations (DAOs), and other blockchain-based innovations are making significant impacts across various sectors.
Since 2009, blockchain has reshaped how we store information, transact, and create. This evolution was just the beginning.
In early 2024, the approval of Bitcoin spot exchange-traded funds (ETFs) in the US triggered a substantial influx of capital into the crypto industry. Recently, there has been mounting pressure to approve additional products, including Ethereum (ETH) and Ripple (XRP) ETFs.
Experts believe these approvals could entice more institutions into the crypto space, leading to further expansion of the blockchain sector.
Despite these advancements, blockchain technology faces a significant challenge: privacy. The transparent nature of blockchain makes it exceedingly difficult for investors to achieve complete privacy. In fact, contrary to popular belief, the very nature of blockchain technology is antithetical to privacy.
Recently, however, several major solutions have emerged to address the privacy crisis within blockchain. Read on to find out what these solutions are, and how you can achieve on-chain privacy.
Privacy Coins: Asset-Specific Anonymity
One popular solution for on-chain anonymity is the use of privacy coins, which provide anonymity for specific assets. Asset-specific privacy refers to protocols embedded within a blockchain to enhance privacy for users of the chain’s native coin.
Consider Bitcoin (BTC); this cryptocurrency marked the advent of a new technology that aimed to replicate the functions and attributes of traditional financial assets, but with a twist.
One of Bitcoin’s fundamental features is the transparency of its ledger technology. Many blockchains that followed Bitcoin maintained this transparency, publicly detailing all transactional information, including sender and recipient addresses.
However, not all blockchains prioritize transparency. Asset-focused privacy in the form of privacy coins was crypto’s first attempt at enhancing privacy.
Dash, Zcash, and Monero were launched between early 2014 and late 2016 to address the privacy dilemma in crypto. However, these chains only enjoyed a brief period of success before facing regulatory challenges.
The native coins of those three chains—DASH, ZEC, and XRM—are the primary beneficiaries of the privacy features within their respective networks. Asset-specific privacy, therefore, refers to protocols implanted within a blockchain that foster privacy primarily for those using the chain’s native coin.
However, a question remains: What privacy protocols are employed in these private cryptocurrencies to obfuscate users’ data?
Zero Knowledge Proofs
Zero Knowledge Proofs (ZKPs), developed about four decades ago by Charles Rackoff, Shafi Goldwasser, and Silvio Micali, have found applications in the crypto space in recent years.
But what are ZKPs? They are technology that allows individuals to prove knowledge or possession of certain information without revealing the actual data. Essentially, two parties can validate information without disclosing the specifics.
Zcash was the first blockchain project to adopt ZKPs to enhance privacy by obfuscating certain details during validation, thereby guaranteeing user anonymity. Polygon, ZkSync, Starknet, and others are among the top projects that have also implemented ZKPs in transactions.
But how do ZKPs work? The two most vital parties in a ZKP system are the prover and verifier. The prover must prove to the verifier that they possess highly confidential information without giving out the information. Only by providing valid proof does the verifier ascertain the truthfulness of the prover’s statement.
Stealth Addresses
Stealth addresses are another cryptographic mechanism used to enhance privacy on-chain. These addresses conceal the recipient’s identity by acting as a one-time proxy for the actual wallet address.
Here is how stealth addresses work:
- Let’s say Person A (let’s call them John) wants to transfer crypto to Person B (let’s call them Bob).
- John initiates the transaction using a stealth address.
- The stealth address is recorded in the blockchain, while John’s address remains private.
- Assets move from the actual address to the exact address of John’s wallet to Bob’s address.
- The blockchain records a stealth/proxy address as the recipient address.
The proxy addresses are cryptographically tied to the recipient’s and sender’s addresses, ensuring that only the transaction participants know the actual addresses. Monero leverages stealth addresses for privacy.
Ring Signatures
Ring signatures are cryptographic constructs that allow one user (the signer) to create a single digital signature on behalf of a bigger group of users. Any group member can perform the signature.
Consider this: In traditional digital signatures, the signer’s identity is often exposed since the signature can be directly linked to the owner. Ring signatures, however, blend the actual signature with others. If one signature signs a transaction, every participant or signature is assumed to have endorsed the message.
Here’s how ring signatures achieve privacy:
- John wants to send crypto assets to Bob.
- The blockchain network in use instantly broadcasts the new transaction.
- Instead of directly signing the transactions, John creates the ring signature.
- John then selects a few decoy addresses. These could include the past public keys of other users. None of these addresses are directly related to the transaction.
- The blockchain ring signature system combines the public key from John’s transaction with the decoy addresses, creating a single ring signature.
- This ring signature can prove the validity of individual transactions without revealing John’s actual address, thus ensuring privacy.
- Only people privy to the transactions can distinguish between the decoy and actual signatures.
PrivateSend from Dash
Introduced in 2014 as part of DarkCoin, PrivateSend aims to maintain the fungibility of the network’s coins by erasing transaction history from the ledger. PrivateSend is essentially a coin mixer within the Dash crypto network.
But why are the coins mixed? Well, the mixing process ensures that no external entity can trace the origin of a particular asset, thus breaking the link between the transaction and the address.
However, unlike other mixers which require external applications, the PrivateSend tool is native to the Dash blockchain, making the mixing process autonomous and seamless.
Here’s how PrivateSend works:
- John initiates a transaction to Bob using PrivateSend.
- The transacted coins are immediately pooled for a sequence of mixing transactions.
- Users must configure settings, including the number of mixing rounds (ranging from 1 to 8) and the target amount of Dash to anonymize.
- The more rounds, the better the mixing and anonymity.
Coinjoins/Coin Mixers
Coinjoins, or privacy pools, are another technology used to enhance on-chain privacy by pooling funds from various sources, making it impossible to distinguish individual assets.
Coinjoins are broken down into:
- Shielded Protocols
- Coin Mixers
Shielded Protocols
Shielded pools bring together users’ funds, making it impossible to trace assets across blockchain networks. The pools disrupt the link between the user’s public key and the assets held in their wallets, ensuring superior privacy.
To use the system, you deposit your coins into a pool operated by an autonomous smart contract, which employs cryptographic techniques to mix the assets, making each deposit indistinguishable from others.
Crypto Coin Mixers (Tumblers)
Coin tumblers mix crypto assets to break the coins’ transaction history, cleaning coins by combining them from various sources. Tumblers sever the link between assets, senders, and recipients.
There are two types of coin mixers:
- Centralized mixers receive assets and send others of equal value, providing tumbling services for crypto assets.
- Decentralized mixers use cryptographic algorithms like CoinJoin and ZKPs to obfuscate transactions.
So, what is the distinguishing feature between shielded pools and coin mixers?
Shielded pools are often seen as apps designed for specific chains, like Zcash. On the other hand, coin mixers are available for a wide range of crypto assets.
However, authorities, especially in the US, have been sending warnings concerning crypto mixers and their ability to obfuscate transactions. Watchdogs believe that mixers are hotspots for money laundering.
Private Execution Virtual Machines
The latest innovation in on-chain privacy enhancement is Privacy Execution Virtual Machines. These machines enable the verification of off-chain computations on-chain, ensuring privacy with ZKPs.
In essence, users can prove the authenticity of their data without publishing the actual data.
Why Privacy Is Important
Understanding how to achieve privacy in blockchain, we must also comprehend its fundamental relevance. Here are a few benefits:
– Enhanced security: Privacy reduces the risk of hacks and frauds.
– Fundamental human right: Privacy is a basic human right, vital in financial activities.
– Protection from restrictions: Privacy protects investors from losing crypto due to tainted coins.
Balancing On-Chain Privacy, Adoption, and Regulation
Privacy and Adoption
Privacy is crucial for the institutional adoption of blockchain. Despite initial disinterest, large institutions and corporations are now gravitating towards crypto.
The Bitcoin ETF hype in early 2024 revealed the increasing interest of massive corporations in blockchain. Large banks, hedge funds, and international merchants are now focusing on blockchain due to its capability to solve significant problems, such as near-instant cross-border transfers. However, privacy concerns have stalled the adoption of crypto in the corporate space.
Note this: Every company has the right to protect its internal secrets about trades, business, and even transactions. The privacy of individuals and companies is almost guaranteed in most jurisdictions.
Yet, if every movement is traceable on-chain, corporate privacy is infringed, exposing companies and clients to security risks. Therefore, many companies’ reservations about joining the blockchain train can be understood.
Privacy and Compliance
Balancing on-chain privacy with regulatory compliance is a significant challenge. While corporations and individuals demand privacy, regulators require compliance with regulations like AML and KYC.
The regulatory burden has led to exchanges delisting private coins like Monero and Zcash. Earlier this year, Binance hinted at delisting Monero, causing a sharp 32% decline in its market value. This was a result of regulatory scrutiny that Binance faced, leading to fines and the imprisonment of a former CEO.
A lack of compliance hinders adoption and enables financial fraud, such as money laundering and terrorist financing. Striking a proper balance between privacy and compliance is essential for increasing adoption in the future.
Conclusion
This guide has explored privacy on the blockchain extensively. Privacy is a crucial yet underdeveloped aspect of the technological universe. Everyone desires privacy in their financial dealings, and institutions want to ensure the security of sensitive data.
The three types of privacy systems—asset-specific, coinjoins, and virtual machines—offer different advantages to users. However, regulators often view privacy as a threat in the blockchain space. Only by achieving a proper balance between privacy and compliance can blockchain projects achieve true adoption.