Why crypto privacy is important
Privacy in crypto is an important topic in this field. Neither companies nor individuals want to make all their information public on blockchain, which can be taken freely, without any restrictions, by local or foreign governments, family members, colleagues, or competitors.
At the moment, there are many experiments and studies of various approaches to achieving privacy in blockchains, but any sufficiently detailed review of this problem has not yet been presented. In this article, we will discuss recent developments and research on crypto privacy.
In the early days of cryptocurrencies, the advent of Bitcoin heralded a new era of anonymous transactions. Indeed, when making a transfer from one crypto wallet to another, you cannot see who exactly is behind this wallet. At the same time, the technological essence of the blockchain network in which these transactions take place records these transfers once and for all. Using this property of the blockchain network, competent authorities of various countries are trying to identify suspicious transactions.
The industry has made tremendous progress from an infrastructure perspective in the ten years since Bitcoin’s inception, but users` privacy in crypto continues to receive undeserved little attention.
It should also be noted that many cryptocurrency users from the very beginning were for some reason convinced that the system provides them with complete anonymity. Although it is still actively supported by mainstream media, this myth has been debunked a long time ago, and there is no secret that law enforcement agencies can quite successfully de-anonymize transaction participants.
With this regard they are helped not only by specialized software providers but also often by ordinary blockchain observers, taking into account that information about each transaction is recorded and publicly available in blockchain. Therefore, one of the best recommendations for conscious users in terms of crypto privacy is to never reuse the same address.
Bitcoin`s confidentiality and its privacy solutions
Despite that Bitcoin is not a privacy coin, it has services that allow keeping the confidentiality of its transfers as a number of technical improvements have been implemented over the past few years aimed at a higher level of users’ crypto privacy.
Among them, first of all, we should highlight so-called mixing technologies such as JoinMarket, CoinShuffle, TumbleBit, and others. Releasing Wasabi Wallet in 2018, based on Bitcoin fungibility, i.e. the same value of all coins regardless of their previous use, can be considered as one of the most significant achievements in this direction of crypto privacy solutions. Mixing of coins with the help of CoinJoin makes them similar and thus ensures privacy in crypto transactions.
Another noteworthy and actively developing technology is called Confidential Transactions. First announced in 2015 by Adam Beck, it uses so-called “Pederson commitments” and makes the transferred amount visible only to direct participants in the transaction or to a designated third party.
Nevertheless, transactions of this kind are not a universal crypto privacy solution, since they only hide the amount of transfer but not the addresses of a sender and a recipient.
A new approach to solving the issue was offered by Bitcoin Core developer Gregory Maxwell. His model involves using of CoinJoin method in order to combine trade outputs into one large transaction, which will hide connections between users from outside observers.
Schnorr signatures, designed to replace Elliptic Curve Digital Signature Algorithm (ECDSA) signatures being in use today, are also among noteworthy Bitcoin improvements. The main difference is that Schnorr signatures make it possible to sign all transaction data at the same time, while ECDSA requires signing each piece of data separately. In addition to network scaling (blockchain data size is reduced by about 25%), the technology increases users` crypto privacy by making it difficult to trace the origin of transactions.
In addition, the mathematical properties of Schnorr signatures will facilitate the development of crypto privacy solutions of smart-contract style such as scriptless scripts, Taproot, and Graftroot. It is noteworthy that these decisions will be displayed on blockchain as regular Bitcoin transactions. This will make it possible to create, for example, futures markets, decentralized exchanges or insurance contracts, where only ordinary-looking transactions will be visible.
Finally, we cannot fail to mention such a crypto privacy solution as Lightning Network (LN) that is actively being developed as a protocol for the second layer of the blockchain networks. Deployed on top of Bitcoin, LN uses smart-contracts in order to achieve higher transaction throughput while maintaining the peer-to-peer nature of Bitcoin protocol.
However, LN’s main feature is that transactions are carried out off-chain, i.e. they are not recorded on publicly available blockchain. Thus, once they have sent funds to payment channels, users can make transactions in a completely anonymous way.
The main misconception now lies in that Bitcoin and crypto coins, in general, are considered as departures from the banking system and associated with inability to track money, but this is not true. If people want crypto privacy, they had better look towards completely different privacy cryptocurrencies.
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Analysts believe that in these conditions, when “privacy and anonymity have become a rarity these days”, demand for so-called private cryptocurrencies should grow, and they “can become a new unique way of self-protection.”
Monero, Dash, Zcoin and Zcash are the most famous privacy coins. All of them are payment systems with their own internal chargeable unit, focused on ensuring complete crypto privacy of financial transactions through cryptographic protocols, which significantly complicate or make it impossible audit network data.
Main difference between all these privacy cryptocurrencies and Bitcoin is that 1shed under the pseudonym Lord Voldemort, and it provided anonymity and high scalability, confirming transactions without needing to store the entire chain history. In addition, Mimblewimble lacks the very concept of blockchain address. With each transfer of funds between users, miners make sure that new coins have not been created during transactions, and that parties involved in the operation have confirmed ownership of their coins using private keys. Transactions are validated using zero-knowledge proofs technologies. Additionally, unlike the most other blockchains, Mimblewimble’s distributed database does not store any form of transaction history.
In January 2019, two new Mimblewimble-based coins such as Grin and Beam entered the market, and although being somewhat different in form and implementation, they offer essentially a general crypto privacy solution to protect users` privacy.
Privacy cryptocurrencies give more chance to cybercriminals, attacking trading platforms or extorting funds through specialized software (for example, WannaCry), to hide movement of stolen money. Japanese Financial Services Agency (FSA) has ordered Bitcoin exchanges to remove Monero, ZCash and Dash from trading. The US Secret Service also spoke about countering anonymous cryptocurrencies.
In terms of technology, criticism mainly comes down to the size of anonymous transactions, which requires a lot of memory from a full node, however, the mentioned updates to Monero and ZCash networks are gradually solving this problem.
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Many people still consider all cryptocurrencies to be anonymous due to active marketing work of many companies, bloggers and others looking to make money in the industry.
Governments and regulators are also honing their tools to limit people’s privacy. Governments may not be able to effectively control cryptocurrencies, but they can still create the laws and regulations related to them. In a regulated environment, cryptocurrency exchanges and brokers are forced to adhere to strict Know Your Customer (KYC) rules and take action to address notorious anti-money laundering and anti-financing of terrorism (AML), which in theory should deter criminal activity.
However, we would prefer to expect our financial activities to be kept under wraps whether it is a traditional banking sector or cryptocurrencies. The right to financial privacy should extend to all technological solutions, regardless of their perceived ability to facilitate money laundering or other illegal activities.
Personal money, and especially money of commercial organizations prefer confidentiality. And not only because they have something to hide. Lack of privacy means lack of safety, this is life behind the glass, where all activities are not only recorded, but also analyzed by third parties. And if we really want cryptocurrencies to become a new type of money, and not a tool for stock speculation, digital currencies should not be less confidential than fiat ones.
Overall, crypto privacy is one of the most interesting areas of current cryptographic research, and there is still a lot to be done in terms of optimization in order to make these theoretical techniques effective enough for real-world practice. Advantage of cryptocurrencies is that they allow direct implementation of the latest developments in terms of privacy aspect. Many privacy techniques used in coins, smart-contracts, and infrastructure were only invented a few years ago. Given how rapidly this area is evolving, privacy of data as well as users` activity will continue to become an increasingly integral part of crypto projects.