Privacy Coins: What Are They & How Do They Work

Cryptocurrencies are digital assets built on blockchain technology. This technology embodies a distributed ledger system that logs transactions across a network of multiple computers. It ensures security and transparency, as each transaction is added to a 'block' and linked in a chain, visible to all network participants.

However, the transparency of blockchain can raise privacy concerns. Traditional cryptocurrencies allow public viewing of all transactions, including wallet addresses and transferred amounts. While these addresses are anonymous, they can sometimes be traced back to individuals.

Privacy coins address these concerns. They are a subset of cryptocurrencies focusing on user anonymity and private transactions. Unlike standard cryptocurrencies, privacy coins employ advanced cryptographic methods to obscure transaction details, enhancing privacy and making fund tracing more challenging.

Key Takeaways

• Privacy coins are cryptos designed to protect user anonymity and transaction privacy.
• The sophisticated cryptographic methods used by privacy coins include zero-knowledge proofs, masking, ring signatures, and stealth addresses, each contributing to enhanced privacy and anonymity.
• Privacy coins face regulatory scrutiny due to their potential use in illicit activities.
• The advanced privacy features of these coins can lead to increased complexity and potential scalability issues.
• Despite challenges, the demand for financial privacy ensures that privacy coins remain a significant part of the cryptocurrency landscape.

What Is a Privacy Coin?

A privacy coin is a form of digital currency which aims to protect the privacy and anonymity of its users.

Unlike traditional cryptocurrencies, which maintain transparent ledgers, privacy coins operate on the principle of concealing transaction data. The wallet addresses and transaction histories are masked, thereby disrupting the traceability inherent in standard cryptocurrencies.

This advanced level of privacy and anonymity caters to a diverse range of users — from individuals valuing personal financial privacy to businesses handling sensitive transactions. Privacy coins serve those for whom confidentiality is not merely a preference, but a critical requirement.

How Do Privacy Coins Work?

Privacy coins leverage sophisticated cryptographic techniques to enhance transaction privacy. These methods, while varying across different coins, are unified in their goal to obscure transaction details, thereby ensuring a higher degree of anonymity and confidentiality.

Zero-Knowledge Proofs

Zero-knowledge proofs are a form of cryptographic protocol that enables one party (the prover) to prove to another (the verifier) that they know a specific piece of information without revealing what that information is. This is akin to demonstrating that you know the combination to a safe without actually opening the safe in front of someone.

In the realm of privacy coins, crypto like Zcash uses ZKPs to validate transactions in a way that ensures the privacy of the transaction details. The procedure entails intricate mathematical formulas that generate a verification of authenticity. This proof demonstrates that the transaction meets all the necessary criteria (like the sender having enough funds) without revealing the sender's identity, the recipient's identity, or the transaction amount.

Specifically, Zcash uses a specific type of ZKP called zk-SNARKs (Zero-Knowledge Succinct Non-Interactive Arguments of Knowledge). Here's a simplified breakdown of how zk-SNARKs work:

1. Creating the Proof. When a user initiates a transaction, the zk-SNARK protocol generates a proof. This proof is a cryptographic representation that confirms the transaction is valid. It's like creating a unique digital fingerprint that says, “This transaction is legitimate”, without revealing any specifics about the transaction itself.
2. Verification. Other participants in the Zcash network can then verify this proof. They use the zk-SNARK algorithm to check that the proof meets all the necessary conditions of a valid transaction. Importantly, this verification process doesn't require access to the transaction's details. Thus, the privacy is maintained.
3. Ensuring Privacy. Because the proof only attests to the validity of the transaction and not its specifics, the details (who sent what amount to whom) remain hidden. It allows Zcash to maintain a ledger of verified transactions without exposing the private financial activities of its users.

Masking

Masking in the realm of privacy coins is a technique used to obscure specific transaction details from public view. For instance, in Monero, it is achieved through Ring Confidential Transactions (RingCT) This feature was designed to hide the amount being transacted. Here's a more detailed look at how it works:

1. Encrypting Transaction Amounts. In the process of masking, the transaction amounts are encrypted. This encryption ensures that only the parties directly involved in the transaction — the sender and the receiver — can view the actual amount being transferred. To any external observer or other participants on the blockchain, these amounts are displayed as indecipherable data. Thus, the value of the transaction is effectively concealed.

1. Use of Cryptographic Techniques. A common cryptographic method used in masking is Pedersen Commitments. It allows the network to verify the integrity of a transaction - ensuring that the total inputs match the total outputs - without needing to reveal the actual transaction amounts. This verification is crucial for maintaining the overall integrity of the cryptocurrency's monetary supply, as it prevents the creation of currency out of thin air.
2. Maintaining Legitimacy and Privacy: The encryption of transaction amounts, coupled with cryptographic verification methods like Pedersen Commitments, ensures that transactions remain both legitimate and private. While the network can verify the validity of a transaction, the specific details regarding the amount transferred remain hidden, thus maintaining the privacy of the transaction.

Ring Signatures

Ring signatures are a form of digital signature that provides a unique blend of anonymity and authenticity in cryptocurrency transactions.

Here's a detailed breakdown of how they work:

1. Combining Signatures: In a ring signature, the actual transaction signer's digital signature is combined with a set of other signatures. These additional signatures are typically taken from past transactions on the blockchain, serving as decoys.
2. Creating Ambiguity: The key feature of a ring signature is that it's computationally infeasible to determine which of the signatures in the 'ring' is the real one. This is akin to having several people sign a document with overlapping signatures, making it impossible to discern who the actual signer is.
3. Preserving Sender Anonymity: When a user sends a transaction, their signature is hidden among these other signatures. To an outside observer, or even other participants in the network, it appears as though any one of the signers could have initiated the transaction. This effectively masks the identity of the actual sender, preserving their anonymity.
4. Ensuring Non-Traceability: The use of ring signatures ensures that transactions cannot be directly traced back to a specific user. This non-traceability is a critical aspect of privacy coins, as it prevents the possibility of transaction history being used to identify or profile users.
5. Maintaining Network Integrity: Despite the anonymity provided, ring signatures still allow the network to verify the authenticity of transactions. They ensure that the sender has the necessary funds and that the transaction adheres to the network's rules, all without revealing the sender's identity.

Stealth Addresses

Stealth addresses offer a robust mechanism for protecting the privacy of transaction recipients. Each time a transaction is initiated, a new, unique address is generated for that specific transaction.

It is similar to using a disposable email address for every new email you send. The primary purpose of stealth addresses is to shield the recipient's real wallet address from being publicly linked to any transaction.

Issues With Privacy Coins

While privacy coins offer significant advantages in terms of transaction anonymity, they also face several challenges and issues that impact their adoption and use.

Privacy Coins and Smart Contracts

Integrating privacy coins with smart contracts presents unique challenges. The privacy features of these coins can sometimes conflict with the need for transparency and verifiably in smart contracts. As a result, it may become difficult to achieve a balance between privacy and functionality.

Privacy Coins and Cryptocurrency Exchanges

Cryptocurrency exchanges often face regulatory challenges when listing privacy coins. The anonymity features of these coins can make it difficult for exchanges to comply with anti-money laundering (AML) and know your customer (KYC) regulations. As a result, some exchanges choose to delist or avoid listing privacy coins from the beginning.

Several privacy coins, including Decred, Dash, Zcash (ZEC), Horizen, PIVX, Navcoin, Secret, Verge, Firo, Beam, Monero (XMR), and MobileCoin were delisted from exchanges in countries like France, Italy, Poland, and Spain. The reason given for this delisting was the need for exchanges to follow local laws and regulations regarding the trading of privacy coins.

Privacy Coins Aren't Legal Everywhere

The legal landscape for privacy coins is highly variable across different countries. Some nations impose bans or restrictions due to concerns about the potential use of coins in illegal activities like money laundering and tax evasion.

Japan was one of the first countries to implement a ban on privacy coins in 2018. Following Japan's lead, South Korea and Australia also removed privacy coins like Monero, Dash, and Zcash from their cryptocurrency exchanges. Dubai has also announced its intention to ban all privacy coins, joining Japan, South Korea, and Australia in their regulatory approach.

In a significant move, Binance, one of the largest cryptocurrency exchanges, delisted 12 privacy coins in several European countries, including France, Italy, Poland, and Spain, effective from June 26, 2023. This decision reflects the growing regulatory pressure on privacy coins in Europe. As of October 26, 2023, Poland has prohibited the sale of privacy coins through its Convert service.

TOP Privacy Coins

Below is a list of the best privacy coins, which have gained attention for their robust privacy features:

Zcash

Zcash is a privacy-focused cryptocurrency that offers users the option of “shielded” transactions. These transactions are encrypted using a zero-knowledge proof construction called zk-SNARKs. The technology allows transactions to be verified without revealing the sender, receiver, or transaction amount. Zcash also offers the option of transparent transactions, giving users the flexibility to choose the level of privacy they prefer.

Dash

Dash is a cryptocurrency that offers a feature called PrivateSend, which provides additional privacy by mixing transactions. It uses a coin-mixing service based on CoinJoin. Multiple transactions from different users are mixed into a single transaction with several outputs, making it more difficult to trace the origin of the funds.

Monero

Monero is considered by many the most private cryptocurrency. It uses ring signatures, ring confidential transactions (RingCT), and stealth addresses to obscure the details of transactions. These featutres make Monero one of the most untraceable cryptocurrencies currently available.

NuCypher

NuCypher is a cryptographic infrastructure for privacy-preserving applications. It provides key management and encryption services, enabling private data sharing, secure computation, and other functionalities that are crucial for maintaining privacy in decentralized systems.

Ghost

Ghost is a private coin that focuses on ensuring the anonymity of online transactions. It employs various privacy-enhancing technologies to make transactions untraceable and secure.

Horizen

Horizen offers a privacy-oriented blockchain platform with sidechain technology. It allows businesses and developers to build private or public blockchains using its unique sidechain protocol, Zendoo, thereby offering enhanced privacy and scalability options.

Keep Network

The Keep Network aims to bridge the gap between public blockchains and private data. It allows users to store and encrypt private data on public blockchains, creating a foundation for secure, private, and interoperable decentralized applications.

Firo

Firo (formerly known as Zcoin) uses the Lelantus protocol, which allows for private transactions without the need for fixed denominations or pre-existing coin mixes. This protocol improves on existing privacy technologies by offering higher practical anonymity.

CloakCoin

CloakCoin is a cryptocurrency that offers a decentralized system of nodes, called "Cloakers," to assist in mixing transactions. This system helps in making transactions more private by preventing the possibility of tracing them back to the original sender.

Pirate Chain

Pirate Chain claims to offer the strongest privacy features of any cryptocurrency. It uses zk-SNARKs technology, which enables transactions to be fully shielded and private, making it nearly impossible to trace transaction details.

Secret (SCRT)

Secret Network is unique for its privacy-preserving smart contracts, known as “secret contracts”. These contracts enable private and secure data processing, allowing users to use decentralized applications without exposing their data.

Status

Status combines a private messenger, secure crypto wallet, and an Ethereum-based browser into one platform. It focuses on user privacy and secure communication, allowing users to interact with the Ethereum blockchain in a private and secure manner.

Zclassic

Zclassic is a fork of Zcash, which removes the 20% fee allocated to the founders in Zcash. It offers similar privacy features as Zcash, but with a focus on a more community-driven approach.

Decred

Decred is a cryptocurrency that emphasizes community governance and decision-making. It includes privacy features as part of its broader aim to create a balanced and sustainable ecosystem.

Verge

Verge is a cryptocurrency that offers privacy through integration with networks like Tor and I2P. It masks users' IP addresses and provides the option of making transactions completely untraceable.

Beam

Beam is a privacy coin that utilizes the Mimblewimble protocol, which allows for both privacy and scalability. Transactions on Beam are private by default, and the blockchain does not store the full history of transactions, further enhancing privacy.

Use Cases

Privacy coins are used in various scenarios where transaction confidentiality is crucial. They are particularly useful for individuals and businesses that require high levels of privacy for their financial dealings. The use cases include protecting trade secrets and securing sensitive personal transactions.

Privacy Coin Bans

The regulatory landscape for privacy coins is complex and varies significantly across different countries. Some nations have outright banned the use of privacy coins, citing concerns over their potential use in illegal activities such as money laundering, tax evasion, and financing terrorism. These bans reflect the challenges that privacy coins face in balancing the need for privacy with regulatory compliance and societal concerns about illegal activities.

Final Thoughts

Privacy coins represent a significant innovation in the realm of digital currencies. They offer a level of privacy and anonymity that is not available in more traditional cryptocurrencies. While they provide essential benefits for user privacy, they also face challenges in terms of regulatory acceptance and potential misuse. The future of privacy coins will likely be shaped by ongoing developments in technology, regulation, and societal attitudes towards privacy and financial transactions.

*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.