Crypto privacy features

Most public blockchains have not added privacy features. Each transaction is publicly posted to the blockchain where anyone can see the sender address, recipient address, amount sent and transaction hash. Still, a recent decision brings crypto-privacy protocols and services into the national spotlight.

The US Treasury Department has sanctioned Tornado Cash – a crypto mixing service used to launder over $7 billion according to the Treasury Department’s official press release. Is this a shot across the bow to privacy-oriented features like mixers, zero-knowledge proofs, ring signatures and stealth addresses?

Let’s start with what Tornado Cash and similar mixing services do. To use Tornado Cash, users must first connect to a Web3 wallet such as MetaMask. They then deposit money into a smart contract that mixes their funds with other users. Users can then withdraw these funds from the mixed pool to a newly created off-chain wallet to the initial deposit address. Through the blending process, services like Tornado Cash break the transaction track.

Think of it as a black box to hide transactions. With enough effort, the authorities can usually find the address of a wallet used to steal money. But when these funds enter the black box, a new wallet can receive the funds without any link to the depositor. The trail is cold. The Lazarus Group, North Korea’s state-sponsored hacking group, used Tornado Cash to transfer over $455 billion to the regime. When these funds can easily be used for nuclear weapons development initiatives, crypto privacy features become a matter of national security. Tornado Cash is just one of many products and services that use mixing.

Why people use privacy features

Despite recent events, crypto’s connection to crime is usually overstated. The idea that crypto is only used for criminal activity stems from Bitcoin’s involvement in the Silk Road. Silk Road was the Amazon of the dark web in the early 2010s, where users could use Bitcoin to buy drugs, fake IDs and other illegal items. The untold story of the Silk Road was that the FBI routinely made Silk Road-related arrests. There were at least 300 Silk Road arrests in less than three years of its existence by some estimates.

In truth, public cryptocurrencies are terrible money laundering tools because all transactions appear on the blockchain. If you know someone’s wallet address, you can see their entire transaction history and the assets associated with that wallet. Blockchain forensics can often link public transactions to real-world users, leading to easy arrests. In fact, according to the 2022 Crypto Crime Report by Chainalysis, only 0.15% of all cryptocurrency transaction volume in 2021 was linked to illegal activity.

Privacy-minded individuals prefer not to have all transactions publicly available on blockchain explorers such as etherscan. There may also be legitimate use cases where privacy is justified such as political donations, dissident journalists or witness protection. Mixers are just one of several privacy-focused features. Others include zero-knowledge proofs, ring signatures, and stealth addresses.

Zero proof of knowledge

With zero-knowledge proof, a party can prove something without revealing more information than necessary. For example, you can prove that you validated a transaction without revealing your public key, or you can prove that your wallet meets a minimum balance without revealing the full amount. It is also the main feature of Zcash, a popular privacy coin.

Zero-knowledge credentials play two major roles in the Web3 movement. Firstly, they ensure data protection. Potential applications include anonymous voting, transactions and digital identity protection. The second role involves giving blockchains the possibility of higher throughput. Zero knowledge aggregates batch transactions into a single proof. Instead of verifying each transaction, validators verify the proof, which results in faster processing times.

Ring signatures and stealth addresses

This technology is used by the privacy coin Monero. With a ring signature, a digital signature is created with the signature itself and a group of decoy signatures. The identity of the signer itself is hidden in a set of possible signers. A stealth address is a one-time public address that is generated for someone to receive money. It is not publicly linked to the wallet address like Bitcoin or Ethereum. Therefore, sharing an address does not give a user access to view your transaction history and held assets.

Monero is currently the leading privacy coin with a market cap of $2.8 billion. While Zcash gives users the choice of regular or shielded transactions, all Monero transactions are private.

Conclusion

A sensible policy for crypto privacy features will involve a balanced approach. Privacy features such as mixers, no-knowledge proofs, ring signatures and stealth addresses give criminals an opportunity to hide stolen funds. The link between The Lazarus Group and Tornado Cash makes that clear.

However, let’s also remember that governments will likely adopt the same privacy features in the near future. Without zero-knowledge proof, everyone’s transaction history on a central bank’s digital currency network will be public information. Paying someone back for dinner will also give you access to their spending habits or seeing someone’s digital identity when they walk into a bar will also give you access to their medical records. Although easier said than done, the goal is to minimize illegal activity while maximizing privacy.

The aforementioned functions are necessary to protect privacy in the digital age. Some use cases should be limited, while others should be allowed to flourish. Like protecting consumers, preventing illegal activity without stifling innovation is a balancing act.