What are Privacy Coins? 

“Privacy is an inherent human right, and a requirement for maintaining the human condition with dignity and respect.” This is a quote from Bruce Schneier, a world-renowned cryptography expert, and computer security specialist. Experts like Schneier are advocates for privacy coins that act as a shield against the watchful eye of governments and large corporations that monitor our online activity and collect our personal data.

This article explores privacy coins and how they work. It will discuss their legality and regulation, as well as why people might need privacy coins. It will also highlight a number of popular privacy coins in the crypto market.

What are privacy coins?

Privacy coins are cryptocurrencies that are designed to maximise privacy and anonymity. When it was released, Bitcoin was praised for being a secure, decentralized, and anonymous method for conducting transactions outside of the traditional financial system.

Bitcoin certainly does add a layer of anonymity because the name and location of each user are never shared. However, all transaction details are maintained in a permanent, public ledger. This means that there is a digital trail of breadcrumbs that can be followed by anyone with the right skillset back to where users originally acquired the coins.

On the other hand, privacy coins generally either have private ledgers or more complex algorithms to conceal wallet addresses and transaction volume, thus greatly improving privacy.

How do privacy coins work?

Privacy coins handle two different aspects of privacy: anonymity and untraceability. Anonymity hides the identity behind the transaction. Untraceability makes it very difficult for third parties to trace or follow a trail of transactions using blockchain analysis.

Privacy coins utilise a range of different strategies and technologies in order to preserve anonymity and untraceability. The most popular of these strategies are CoinJoin, stealth addresses, and zk-SNARKs.

Most popular stealth technologies

CoinJoin is a technology that melds together multiple transactions from individuals into a single transaction and then distributes them again using new addresses. Imagine a group of people, all with a quarter packet of spaghetti. They mix all their spaghetti together, cook it up, and then serve it up to each person. It would be very difficult to determine whose spaghetti was whose. Some users utilise this technology to increase the privacy of Bitcoin transactions. Additionally, some cryptocurrencies like Dash (DASH) are built using CoinJoin technology.

Stealth addresses work by generating a new address for every transaction, which makes it very difficult to link a transaction to a sender. This would be like using a different mobile every time you make a phone call. Stealth addresses are a key part of the security architecture of the popular privacy coin Monero (XMR).

Another popular privacy technology is zk-SNARKs (Zero-Knowledge Succinct Non-Interactive Argument of Knowledge), which was first adopted in the crypto space by the privacy coin, Zcash (ZEC). Zk-SNARKs allows users to prove a transaction’s validity without revealing key identifying information, such as account balances or the parties involved. This is similar to having a photograph of yourself at a U2 concert: it proves you were there, but not who you are.

Privacy coins and regulation

Privacy coins are often the target of government regulation. Some governments fear that they will be used for illicit transactions in exchange for illegal goods and to facilitate activities like money laundering and terrorism. However, advocates of privacy coins argue that cash can be used in the same way, and that governments are not entitled to our private data or spending habits. In fact, in 2020 the UN reported that over $1.6 trillion USD in traditional funds is money laundered every year.

A research report from Elliptic suggests that only 1% of digital assets are used for illicit activities. And of this small portion, the overwhelming majority of this activity is related to cryptocurrency scams, not activities like money laundering or terrorism, which governments fear. However, government agencies around the world continue to regulate or ban privacy coins.

Are privacy coins legal?

The legality of privacy coins is entirely dependent on where you live. Some countries, such as South Korea, have only banned the trading of privacy coins on cryptocurrency exchanges. Whereas countries like Japan have taken a more hard-line approach and banned privacy coins altogether. Countries like Australia sit in a bit of a grey area: privacy coins like Monero are banned, while others such as Zcash, Dash, and Verge are still on offer.

Why do I need private transactions?

It is well known that governments around the world and large social media corporations collect and monitor the data of citizens and users. Governments argue that surveillance systems are for the good of the people, to help prevent things like crime and terrorism. And, in relation to social media, if you’re not paying for the product, you are the product.

Governments often use the “nothing to hide” argument to justify monitoring or surveillance programs. The essence of this argument is that people have nothing to fear, as long as they have nothing to hide. Edward Snowden refutes this argument, saying: “Arguing that you don’t care about the right to privacy because you have nothing to hide is no different than saying you don’t care about free speech because you have nothing to say.”

Many consider privacy to be a human right, one that is certainly under a lot of scrutiny in our modern age. Cryptocurrencies like Bitcoin help preserve people’s anonymity, but they do not offer complete privacy. Privacy coins, along with virtual private networks (VPNs), messaging platforms like Signal, and web browsing services such as The Onion Router (TOR), allow people to truly live private lives.

Most popular privacy coins

This section highlights the unique features of the most popular privacy coins.

Monero

Monero (XMR), released in April 2014, is the most widely used privacy coin in the world (and the coin with the largest market cap). It is regarded by many experts as the gold standard because of the complex algorithms it uses to obscure addresses, balances, transaction amounts, and transaction histories. Monero uses a number of cutting-edge technologies, such as stealth addresses and ring signatures to achieve this.

Stealth addresses, as covered above, generate a new address for each transaction, which makes it very difficult to link transactions to senders.

Ring signatures obscure the output (the amount of XMR sent) used in a transaction by creating a ring of decoy outputs. These outputs are made up of real past outputs from the Monero blockchain but have nothing to do with the current transaction. For this reason, these outputs are equally as probable as the real ones.

Monero also uses another technology called ring confidential transactions (RingCT) to help obscure transaction amounts.

Zcash

Zcash (ZEC), which launched in October 2016, is another widely popular privacy-focused coin. It has a completely different security architecture than Monero. Unlike Monero, which is private by default, Zcash gives users the option to make public transactions (using t-addresses) or private transactions (using z-addresses).

The foundation of Zcash is the privacy technology, zk-SNARKS, and a concept known as “zero-knowledge proofs”. A zero-knowledge proof is a situation where each party in a transaction can verify to each other that they have a particular set of information, without revealing what the information is. For instance, a tracking number on a parcel proves that you have sent a parcel and provides information on where it is, but it doesn’t reveal what is contained within the parcel.

Private money is just one use case for this powerful and versatile technology though. Zk-SNARKs and zero-knowledge proofs could have many applications, such as intelligence gathering and political elections for instance.

Dash

Dash (DASH), which was launched in January 2014, is the world’s oldest privacy coin (beating Monero to the punch by about three months). The Dash whitepaper, co-authored by Evan Duffield and Daniel Diaz, describes Dash as “the first privacy­-centric cryptographic currency based on the work of Satoshi Nakamoto”. So, in essence, the developers wanted to create a private version of Bitcoin.

Although Dash does still feature strong encryption features (including an opt-in privacy function, similar to Zcash), the company has pivoted away from the privacy features of the coin. Dash now aims to be a go-to digital currency for everyday transactions, which has privacy features as a bonus.

Dash is a hard fork from the Bitcoin protocol, which means that it is based on the same code as Bitcoin. That also means that Dash has the anonymity of Bitcoin built into its design. But Dash also uses CoinJoin and other technologies to scramble transactions and make them difficult to trace, which adds a level of privacy that Bitcoin does not have.

Verge

Verge (XVG) takes a slightly different approach to the coins above. Verge’s privacy relies on existing and tested technology, such as TOR, to obscure the location and IP address of users making transactions. An IP address is a series of numbers associated with a particular computer or network that can be used to identify users and track their online activity. In many ways Verge operates in a similar manner to a VPN.

Verge tries to tackle the issue of privacy technically, rather than relying too heavily on cryptography, which other currencies like Monero are entirely based on. Because Verge doesn’t rely on cryptography, which can be slow and computationally expensive, it means that it is much quicker than a lot of other privacy coins, which is a huge benefit to everyday users.

The future of privacy coins

Along with the threat of additional regulation, law enforcement agencies and analytics firms are also increasing their efforts to break privacy coins. In September 2020, the Internal Revenue Service (IRS) confirmed that they had awarded a pair of contracts worth as much as $1.25 million USD in total to companies attempting to develop tools to trace Monero transactions.

More recently, in May 2021, Norway’s National Cybercrime Center divulged that they were trying to crack both Monero and Dash in relation to a missing persons case. It remains unclear whether these attempts produced reliable Monero tracing tools or not.

Despite ongoing regulation battles and attempts to crack privacy coins, they appear to be gaining popularity. The social narrative around the need for privacy is building in strength. Some experts believe that the age of privacy coins is almost upon us.

Summary

While Bitcoin preserves a user’s anonymity, there are ways to trace transactions and link them to the people who made them. Therefore, it is not a truly private currency. Privacy coins are designed to maximise privacy and anonymity. Despite heavy regulation and bans imposed by governments around the world, privacy coins continue to gain traction, especially as the privacy narrative picks up steam.