Block by Block: Privacy Coins

Block by Block is a series where we dive into different industries and examine the entry points for decentralization.

Privacy is a theme deeply embedded in the crypto ecosystem. The original cypherpunks believed privacy is a natural right for society, especially in the age of the internet. In fact, in the now famous “A Cypherpunk’s Manifesto,” Eric Hughes stated “Privacy is necessary for an open society in the electronic age,” and that “We must defend our own privacy if we expect to have any.”

In the bitcoin whitepaper, Satoshi Nakamoto dedicated a whole section to privacy. In the early growth stages of bitcoin, the topic has not received as much attention as perhaps it should. Fortunately, privacy has gotten a lot more attention from the core developers with the introduction of many promising privacy-enhancing solutions. With renewed focus, we felt it is time to examine privacy coins and whether or not they are an important class in the crypto ecosystem.

Where is the point of entry?

Due to the public nature of the blockchains, it was soon discovered that one could identify individuals based on the structure of their transactions and the use of their addresses. Startups such as Chainalysis and ChipherTrace have popped up to de-anonymize blockchain transactions and help law enforcement entities “prevent, detect, and investigate cryptocurrency money laundering, fraud, and compliance violations.” So so that leaves users trying to maintain privacy in need of solutions.

How do privacy coins solve the issue of transparency?

• Encryption: Privacy coins have employed a variety of cryptographic techniques to encrypt transactions and users. These techniques can effectively hide wallet addresses and the number of transactions coming and going from these addresses. Notable implementations include Confidential Transactions, implemented on Monero, and zk-SNARKS, implemented on Zcash.
• Mixing: Privacy coins have also leveraged mixing tools to shield users and their transactions. Coin mixers essentially combine multiple transactions to obscure the directions of a specific transaction, preventing third parties from connecting a transaction to an individual.

What are the barriers to entry?

• Scaling: At their current state, most privacy coins are difficult to scale. This is because the cryptographic math used to create private transactions is extremely data heavy. If privacy coins are unable to scale while maintaining their privacy features, they would not be suitable for mass adoption.
• Adoption: As we’ve mentioned previously in our social media post, consumers often value convenience over privacy. Inconvenience is a large barrier to adopting privacy coins. Because of their heavy data load and the negative association with private transactions, there is limited third-party support (wallets, exchanges, etc.) for privacy coins. The inconvenience of buying and storing privacy coins could slow down their adoption.
• Bitcoin: In the recent months we’ve seen an increase in privacy development around bitcoin. Bitcoin with its liquidity, brand, and third-party support could discourage the adoption of privacy coins if it can implement similar privacy features in the near term.

“To be left alone is the most precious thing one can ask of the modern world.” — Anthony Burgess, English writer, and composer

For cryptocurrencies to be fungible, they need privacy features. While debates continue on whether privacy features should be implemented on-chain (on the network) or off-chain (third-party tools and services) one fact remains true, privacy is vital to the success of cryptocurrencies.