Crypto Privacy Features

Most public blockchains do not have added privacy features. Every transaction is publicly posted to the blockchain where anyone can see the sending address, receiving address, amount sent, and transaction hash. Yet a recent decision brings crypto privacy protocols and services into the national spotlight.

The United States 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 a Web3 wallet like MetaMask. They then deposit funds into a smart contract that mixes their funds with other users. Users can then withdraw those funds from the mixed pool into a newly created wallet with no on-chain connection to the initial depositing address. Through the mixing process, services like Tornado Cash break the transaction trail.

Think of it as a black box to obfuscate transactions. With enough effort, authorities can normally find the address of a wallet used to steal funds. Yet once those funds go into the black box, a new wallet can receive the funds with no link to the depositor. The trail goes cold. The Lazarus Group, North Korea’s state sponsored hacking group, used Tornado Cash to funnel over $455 billion to the regime. When those funds can easily be used for nuclear weapons development initiatives, crypto privacy features become a matter of national security. Tornado Cash is only one of many products and services that use mixing.

Why People Use Privacy Features

In spite of 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. The Silk Road was the Amazon of the dark web in the early 2010s, where users could use Bitcoin to purchase 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 according to some estimates.

In truth, public cryptocurrencies are terrible money laundering tools because all transactions are displayed on the blockchain. If you know someone’s wallet address, you can see their entire transaction history and the assets tied to that wallet. Blockchain forensics can oftentimes tie 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 tied to illicit activity.

Privacy oriented individuals prefer to not have every transaction publicly available on blockchain explorers like etherscan. There might also be legitimate use cases where privacy is warranted like political donations, dissident journalists, or witness protection. Mixers are only one of several privacy-focused features. Others include Zero-knowledge proofs, ring signatures, and stealth addresses.

Zero-Knowledge Proofs

With Zero-knowledge proofs, one party can prove something without revealing any 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 entire amount. It is also the staple feature of Zcash, a popular privacy coin.

Zero-knowledge proofs play two large roles in the Web3 movement. First, they ensure data privacy. Potential applications include anonymous voting, transactions, and digital identity protection. The second role involves giving blockchains the ability for higher throughput. Zero-knowledge rollups batch transactions into a single proof. Instead of verifying every transaction, validators verify the proof allowing for 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 actual signature and a group of decoy signatures. The actual signer’s identity is obscured in a set of possible signers. A stealth address is a one-time public address that is generated for someone to receive funds. It is not publicly tied to the wallet address like Bitcoin or Ethereum. Therefore, sharing an address does not give a user access to view your transaction history and custodied assets.

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

Conclusion

A sensible policy towards crypto privacy features will involve a balanced approach. Privacy features like mixers, zero-knowledge proofs, ring signatures, and stealth addresses provide an avenue for criminals to obfuscate stolen funds. The link between The Lazarus Group and Tornado Cash makes that clear.

However, let’s also remember that governments will likely adopt these same privacy features in the near future. Without zero-knowledge proofs, everyone’s transaction history on a Central Bank 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 as they enter a bar will also give you access to their medical records. Though easier said than done, the goal is to minimize illicit activity while maximizing privacy.

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