Privacy Coins: Blow for Freedom — or Boon for Crime?

In the controversial world of cryptocurrency, there’s very little more controversial than privacy coins, a subtype of digital assets designed specifically to be impossible to trace.

At the core of that controversy is a philosophical argument: Are digital assets like Monero (XMR), Zcash (ZEC) and Dash (DASH) a way for people to protect the their finances and transactions from the prying eyes or a way to evade taxes and hide ill-gotten gains?

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On the tool-of-criminals side are elected officials and law enforcement, both of whom are becoming more concerned about their skill in tracing pseudonymous bitcoin transactions. Two years ago, the IRS spent nearly $2 million in contracts and bounties for anyone who could crack monero, the No. 1 privacy coin. And in recent hearings about crypto’s use in evading Russian sanctions, Sen. Elizabeth Warren, D-Mass., suggested that oligarchs could be using them to shift billions of dollars.

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While the latter was shot down fairly convincingly at the hearing by blockchain data and tracking firm Chainalysis co-founder Jonathan Levin — who pointed out that there wasn’t nearly enough liquidity for that — ransomware hackers have been shifting to monero, sometimes offering discounts for privacy coin payments.

The other side is more theoretical, but also gaining traction with a wider audience than its original backers from cryptocurrency’s libertarian roots — although that’s still there, as evinced by revelations in late April that National Security Administration (NSA) whistleblower/fugitive Edward Snowden was a key supporter of No. 2 cryptocurrency Zcash, participating anonymously in the encryption “ceremony” that launched it in 2016.

More broadly, there has been a growing focus on privacy since the central bank digital currency (CBDC) push began. With some 90 of the world’s largest economies, including the U.S. and EU, looking into them — as well as China’s “controllably anonymous” digital yuan on the cusp of launch and India committed to a digital rupee — concern about governments being able to see where, when and what people buy with a warrant or even request it from a private company is growing.

That argument isn’t limited to privacy coins.

Indeed, a fair chunk of the opposition in the public comments to the Fed in its ongoing investigation of a digital dollar were to the effect of “Keep the government’s nose out of my business.” That’s a bit different from Fed Chairman Jerome Powell’s insistence that a U.S. CBDC would have to be private but also “identity verifiable.” And President Joe Biden’s March cryptocurrency executive order called privacy a “priority” but also noted the need for anti-money-laundering (AML) controls.

See more: Biden’s Executive Order Set to Fast-Track Crypto Policy

How Privacy Coins Work

Both Monero and Zcash use an encryption technique called zk-snarks, which makes it possible to confirm whether a transaction has taken place without giving away any details, like the sending and receiving wallet addresses or the amount. In part, they act like mixing services, which co-mingle multiple transactions to hide senders and recipients.

Read more: Crypto Crime Series: When Privacy Counts, Crypto Users Turn to Mixing Services

But there are differences. Monero uses a variety of techniques to hide all transaction information, including creating one-time-only “stealth” and decoy addresses, and adding “decoy” coins to transactions to hide the amount sent — otherwise, if someone buys 1.233 BTC worth of monero and someone else receives that amount, putting 2-plus-2 together is fairly simple. Also, unlike other privacy coins, all transactions are private.

Related reading: Privacy Coin Monero May Be Facing Security Concerns of its Own

Other privacy coins like Zcash and Dash let users choose whether to make transactions private. In practice, so few users did so that blockchain intelligence firms like Chainalysis and CipherTrace, as well as academics, said they could trace most transactions.

That changed this week for Zcash, which launched a major upgrade that added several other features, including switching the default setting to anonymous rather than open, adding what it calls unified addresses that allow the recipient to receive coins anonymously even if the sender does not, and — in a potentially big move for the privacy coin sector — added mobile wallet capability that can bring private transactions to decidedly un-private smartphones.

Mounting Pressure

The desire for privacy in payments of any kind is strong; digital yuan head Mu Changchun said as much when discussing controllable anonymity of China’s CBDC.

“We know the demand from the general public is to keep anonymity by using paper money and coins,” he said in 2019. “We will give those people who demand it anonymity in their transactions. But at the same time we will keep the balance between the ‘controllable anonymity’ and anti-money laundering, CTF [counter terrorist financing], and also tax issues, online gambling and any electronic criminal activities.”

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More broadly, a number of top exchanges have delisted privacy coins under pressure from regulators and politicians. Both South Korea and Japan have outright banned trading in privacy coins.

In South Korea, the pressure is great enough that some exchanges are reportedly considering delisting Litecoin, the oldest currency-replacement cryptocurrency alternative to bitcoin, due to privacy features and legal changes that may impact its 2019-era, opt-in confidential transaction feature.

There’s also mounting pressure in the U.S.

When the exchange Bittrex delisted the three top privacy coins on New Year’s Day 2021, well-known crypto attorney Jake Chervinsky, head of policy for the Blockchain Association, called the move “deeply disappointing” on Twitter.

Rights vs. Wrongs

“Privacy is a constitutional right, not a crime,” he said of removing coins with “privacy-preserving features” due to pressure — although he added that he was “speculating” about the cause of Bittrex’s decision.

“There’s no law or regulation requiring this, just DOJ’s opinion that privacy is ‘indicative of possible criminal conduct,’” Chervinsky added.

This referred to a Trump administration report that said the use of “anonymity enhanced cryptocurrencies” was a “high-risk activity that is indicative of possible criminal conduct.”

It remains an issue of concern to privacy-minded crypto supporters.

In March, Monero developer Justin Ehrenhofer told Cointelegraph that without the anonymity, or at least pseudoanonymity, of cryptocurrencies like Bitcoin that make transaction information public but hide the identity of senders and recipients behind encryption codes, digital assets lose a key attribute: fungibility. This would mean that one token would become replaceable with any other — much like dollar bills.

“This opens the door to mass surveillance and the assignment of proprietary risk scores to everyone’s money, which in turn makes transparent assets nonfungible in practice,” he said.