What are Privacy Coins?
Privacy coins are particular types of cryptocurrencies that conceal crucial financial information of its users. Privacy coins hide their users’ identity, the starting point, and the destination of their transactions.
They contrast with other traditional cryptocurrencies like Bitcoin in that they have private wallets. With Bitcoin, for instance, anyone can access the public wallet address of the origin of the currency and the receiver. Moreover, anybody can snoop into the amounts held in wallets or those transferred. Bitcoin is not anonymous, but pseudo-anonymous. If you know who owns a wallet, you can see all his/her transactions.
Privacy coins claim to provide improved security controls for the central goal of hiding the user identities and their financial transactions. They accumulate a massive number of transactions together with their wallet addresses to conceal their origin. However, some whitepapers reveal a probability of tracing privacy coin trails, making them less than 100% anonymous.
How Privacy Coins operate
To better understand the operation of Privacy coins, let’s use Bitcoin or Ethereum’s transactions to draw a comparison. Though the identities of the latter’s blockchain users remain hidden via cryptography, the transactions are publicly posted on the respective public blockchains. The transactions remain perpetually be accessible by anyone.
However, it’s important to note that a blockchain user has to find somewhere to cash out at the end of the day. To achieve that, the involved Bitcoin or Ethereum account must be linked to a bank account, thus a person. The linking creates a loophole for associating an unknown address to a known identity, creating a privacy breach. The linking scenario makes such blockchain’s semi-anonymous.
Privacy coins operate in two dimensions when it comes to enhancing user data privacy on the blockchain. The anonymity dimension cuts off the user identity from their crypto wallets and the transactions they make.
On the other hand, privacy coins boost untraceability. This operational dimension involves special computerized functions that keep the prying public eyes from conducting a chain analysis from your blockchain transfers and receipts’ entries.
Privacy algorithms utilized by Privacy Coins
Different privacy coins use different system algorithms to achieve their two-dimensional role of hiding user identities and turning money trails into a confusing maze of transactions.
RingCT, Coinjoin, and zk-Snarks algorithms are the most prominent.
The Ring Confidential Transactions (RingCT) algorithm uses ring signatures that enable users to conceal their transaction entries and the amounts involved. The process also masks the receiving address to give secrecy to its blockchain users entirely. This method is in use by Monero privacy coin.
The Coinjoin algorithm uses a “safety in numbers” concept. For instance, when two distinct users send money with similar amounts, the algorithm converts the two unique transactions into a single payment. The conversion makes it impossible to match inputs with outputs and thus maintain a high level of privacy.
One variant of Coinjoin, dubbed PrivateSend, is utilized by Dash privacy coin. Another variant, Cash Shuffle, is under trials by Bitcoin Cash.
zk-Snarks refers to a zero-knowledge technology where miners authenticate transactions, but never uncover the identity of the sender or receiver of the coins. Through cryptographic hash, both parties can verify the authenticity of an entry. However, the process doesn’t disclose the finer details of the sender, receiver, nor the amounts involved.
zk-Snarks is in use by the Zcash and most of Zero coins, though Ethereum is interested in it and trials are underway.
The Advantages of Privacy Coins
The idea of privacy appeals to almost everyone. The 21st-century wave of internet privacy has fueled crypto-privacy, which in turn gave birth to privacy coins. These are the benefits of privacy coins.
The concept of a public ledger is useful, but it doesn’t serve the interests of all. Consider a profit-making entity in a competitive market with business secrets or a vast client base it wants to keep a top-secret. Privacy coins would work well for them since the destinations, and the amounts involved in their transactions would remain private.
Further, cryptocurrency users have a right to privacy, and more so in this modern era where personal information fuels decisions and strategies. Consider a local authority or government with access to your personal information. The exposure comes with the risk of surveillance and undue control or manipulation.
Privacy is vital when it comes to finances. Governments, fraudsters, and other malicious individuals can use the exposed data for exploitation. Anonymity, therefore, not only safeguards your identities but keeps you away from being unfairly targeted.
Let’s use an example of a business transacting high volumes of Bitcoin with its clients. It could attract scrutiny from hackers or competitors. Some Twitter accounts publicly post notable Bitcoin transactions that may catch the attention of malicious actors who trail the account and dig up the owner’s personal information. Cyber-attacks may soon follow.
The downside of Privacy Coins
Even though privacy coins promise legitimate blockchain users the secrecy of their financial affairs, there is a concern that the anonymity will attract bad actors. Moreover, the operations of privacy coins are resource-intensive with slow transaction rates. The extra features push the transaction charges a rung higher than the standard cryptocurrency transactions.
Ultimately central governments may argue against them and even ban them due to the stigma they hold. Governments see these coins as perfect mechanisms for money laundering and terrorism. South Korea disallowed all digital currency exchanges that hide the identity of its end users. Privacy coins are considered an emerging threat to United States national security, at least according to Robert Novey-a Secret Service director. Privacy coins are also forbidden on most European exchanges and brokers. This results in that it is hard to convert a privacy coin to fiat.
3 most popular Privacy Coins
Though there are more than 50 privacy coins, these are the most popular.
Though a victim of several security flaws, Monero tops the privacy coins list with a market cap of $2.26B. Its popularity hinges on its use of the ring signatures and hidden account numbers that conceal the origin and destination of transactions. All transactions have the identity details hidden by default.
CipherTrace recently reported that they possible can track Monero transactions.
Dash boasts of the striking PrivateSend feature that grants users the opportunity to choose their transactions’ privacy status. However, the PrivateSend feature comes with an increased transaction cost. Dash has a market cap of $885.16m.
Zcash is a privacy coin that mirrors Bitcoin though it departs from the traditional Bitcoin attributes because its privacy option. As an user, you can choose to activate the privacy options or deactivate them. Zcash has a current market cap of $721.26M. Just like Bitcoin, it has a fixed supply of 21 billion.
The Future of Privacy Coins
The fact that privacy coins create the room for anonymous crypto trading doesn’t mean that their creation was malicious. Absolute anonymity indeed creates a loophole for illegal activity that is hard to investigate.
On the other hand, the absence of privacy may draw unwanted attention from malicious actors. Privacy coins come with barriers to access, which may impede their uptake for the darknet transactions. Perhaps that explains Dash and Monero’s rise and falling trends since June 2020. However, with the hard to predict crypto industry, we have to wait and see how privacy coins cope with their challenges and how different authorities perceive them.