Cryptocurrencies like Bitcoin and Ethereum are the most popular of their kind, and a major selling point is the degree of anonymity they provide. However, these coins aren’t privacy coins, as some investors think they are. In fact, the open-source nature of blockchain technology enables Bitcoin transactions to be entirely public via the technology’s distributed ledger, not to mention the know-your-customer policies implemented across most exchanges.
Bitcoin offers less privacy than fiat currencies in certain aspects since it is built to exist on a public blockchain. This further implies that anyone with ample resources to perform chain analysis could uncover the real identity behind a public address. However, in the case of a person that wants to trade cryptocurrencies entirely anonymously, what happens? Well, this is where privacy coins are most useful.
Now, privacy coins are similar to traditional cryptocurrency but have a unique feature: they hide wallet addresses and obscure information that could be used to trace anything back to a wallet owner. Owing to its controversial nature, this asset class has since attracted many investors alongside the tough hands of governments.
Regardless, over 90 privacy coins are traded today to suit every investor’s most important needs, with the top three by market cap being Monero (XMR), Zcash (ZEC), and Decred (DCR). That being said, this piece will address what privacy coins are, how they work, legality and regulation, and what potential investors should be aware of. Let’s dig in!
What Are Privacy Coins?
The answer to this lies in the name itself. Basically, a privacy coin keeps the user’s identity and other transaction data private. Let’s elaborate a bit.
Privacy coins, also called “private coins” or “anonymous coins,” are cryptocurrencies that hide any information that can link an individual to a transaction and other information such as the amount transacted and current balances of wallet addresses.
For instance, the buyer and sender of a transaction will know the amount transacted and the parties involved (themselves), but this information will be unavailable to anybody else. This allows users to maintain their anonymity and hide their transaction activity.
To be completely anonymous, it has to be impossible to link the various transactions the same person had made previously. However, not all privacy coins offer the exact same level of privacy, as they vary in their degree of anonymity. So, how exactly do privacy coins work?
How Do Privacy Coins Work?
Privacy coins are not all that different from normal cryptocurrencies. For example, they still rely on a public ledger, and you could still see that a transaction has occurred, but you would be unable to track wallet addresses easily.
Privacy coins keep the flow of money on their networks from the public eye, say governments and other institutions that might want to track the transaction’s source. They do this by restricting vital information involved in a transaction (e.g., wallet addresses, transaction amounts, senders’ and receivers’ wallet addresses, etc.) from public view.
If you send a private coin to another address, other users cannot access the details of the transaction. Albeit, there are many privacy coins out there, many of which use their own methods to ensure anonymity, each to varying degrees of success. Below are three cryptographic techniques that some privacy coins employ:
1. Stealth Addresses: Every transaction generates a new address to protect the recipient’s privacy.
2. Zk-SNARKs: Zk-SNARKs, an acronym for zero-knowledge succinct non-interactive argument of knowledge, allows you to prove that a transaction is valid without sharing its details (sender, receiver, amount).
3. Ring Signatures: When you sign a transaction with a private key, others can link your signature to your address. Ring signatures prevent that from happening. Since there are various signatures in the same transaction, it becomes harder for others to connect your signature to your address.
Pros and Cons of Using Privacy Coins
Many investors prefer to use privacy coins as a better alternative to Bitcoin and other public cryptocurrencies. One of the notable reasons for that is anonymity in trading. However, despite their great benefits, privacy coins also have their disadvantages.
Pros of Using Privacy Coins
Fundamentally, privacy coins are appealing to investors who want anonymity. While the public ledger aspect of blockchain technology is useful, it doesn’t serve every investor’s needs. Privacy coins guarantee that users can transact any amount to any person without scrutiny. With a vast amount of personal information now a commodity, many people value privacy over anything else.
2. Financial Security
Privacy coins do more than protect identities; they also prevent an individual from having a target on their back by governments and companies. For instance, a business or person that transacts large amounts with clients, competitors, or hackers could be investigated. Anonymity prevents the public from knowing who participates in a deal or how much it is for.
Cons of Using Privacy Coins
1. Higher Transaction Fees
Privacy coin transactions have all of these extra features, suggesting that transaction fees are generally higher, which also translates to higher gas fees.
2. Illegal Activities
Privacy coins can be used for illegal activities; besides generally being used to purchase illegal goods on the black market, they can also be used for money laundering or tax evasion.
3. Government Ban
Because of all the possible ways privacy coins can be misused, some countries have banned their use. Whenever a privacy coin is banned in a country, its price may drastically decline, a move that could potentially harm investors.
Legality of Privacy Coins: Why Is There So Much Fuss About Them?
Well, the legality of privacy coins depends solely on the context or jurisdiction within which it is being discussed or utilized. Some countries are pretty much open to privacy coins, while some have taken the hammer approach toward privacy coins. For example, South Korea prohibits trading privacy coins on the country’s crypto exchanges to curb money laundering.
Japan is no different. The country imposed a ban on all cryptocurrencies that provide a sufficient degree of anonymity, with Japan’s Financial Security Agency (FSA) stating the primary reason for the ban is to deter illicit activities in the cryptocurrency marketplace.
In Australia, cryptocurrency exchanges delisted privacy coins amid regulatory and banking pressure. The blockchain analysis firm Chainalysis is believed to have played a large part in the decisions made by Australia and others. In the same fashion, the Financial Action Task Force, or FATF, listed privacy coins as a potential red flag for money laundering through virtual assets.
However, countries that haven’t banned private coins haven’t endorsed them either. In the United States, privacy coins are legal, but the Secret Service recommended that Congress regulate privately enhanced cryptocurrencies.
What’s the Future of Privacy Coins?
Privacy coins have a strong utility, and their inherent ability to enable more discrete transactions on the blockchain won’t fade away anytime soon. While things are uncertain for them regarding regulation, they offer something that many people want in their financial spending and beyond, anonymity.
Exchange platforms delisting privacy coins like Dash (DASH), Decred (DCR), Firo (FIRO), and Monero (XMR) definitely make it a tad harder for the average investor to get their hands on them or use them. But some peer-to-peer marketplaces and anonymity-focused trading venues will happily facilitate the use of BTC and other digital assets for XMR.
The future does seem a bit unclear for privacy coins, which perhaps will reduce the number of people speculating on them. However, those who really need privacy will still find a way to buy privacy coins. Anonymity will remain in demand for years to come, potentially giving privacy coins a brighter time to shine.
And for Investors?
It might be risky to invest in privacy coins right now, but they are not going away. They will likely go mainstream at some point, just as Bitcoin has. After all, privacy coins are like any other crypto, with an added layer of security and privacy.
Meanwhile, potential investors should keep a close eye on regulatory developments in most major countries, particularly the United States. Generally, cryptocurrencies have always been subject to regulatory risk, which you should keep in mind if you decide to invest in privacy coins.
Why You Should Care
Privacy coins have come a long way since 2014. While they enjoyed recent success by offering true anonymity for investors, they are also faced with obstacles that arise from being associated with illegal activities. However, privacy coins have a future, for as long as every person in the world wants data protection and privacy.