Overview of Anonymous Privacy Cryptos

Written by Harsh Bhutani with contributions from T C.

Privacy coins in cryptocurrency are a subset of cryptoassets rapidly gaining attention from mainstream crypto investors. Privacy and anonymity have become marketing buzzwords for all cryptos, helping bring attention to the crypto investing arena. Privacy is an oft-cited reason for interest from new crypto investors and users. However, many in crypto are not fully aware of the public nature of most blockchain transactions. The vast majority of cryptocurrency transactions occur on public traceable blockchains.

Many investors believe that all cryptocurrency is private and anonymous, but this isn’t the case. While blockchain addresses don’t contain identification data, addresses can be traced to specific individuals or entities by analyzing the public blockchain transaction record. Entry and exit to crypto ownership and investment often involves exchanges that obtain and maintain records of account holder’s personal information to comply with anti-money laundering (AML) and Know Your Customer (KYC) laws. Any transactions from that point on can be traced back to a specific individual identity. The entire transaction history of most cryptocurrencies is recorded on an immutable blockchain that anyone can search. The company Chainalysis has been consulted by both the US Internal Revenue Service and the FBI to track owners of virtual currency blockchain addresses to detect tax evasion and criminal activity.

While bitcoin is certainly the best known cryptocurrency, many bitcoin users incorrectly assume their transactions are anonymous. However, true anonymous privacy cryptos are rapidly gaining attention and interest of savvy crypto users. There may be compelling reasons for new investors to consider allocating a portion of their cryptoasset portfolio in privacy coins to improve diversification.

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In crypto transactions, the transacted amount simply gets assigned a new address on the blockchain. It is possible for a completely legal bitcoin or crypto user to end up owning coins that have previously been used for illicit purposes. The entire history of those coins is permanently recorded on the blockchain. Therefore, crypto investors could become unknowing holders of coins with a history of prior criminal use. Investing in and spending anonymous privacy cryptos can avoid this. Some of the most used privacy coins will be discussed here, while some of the regulations and legal hurdles will also be covered.

Seizing on an opportunity to provide advantages to distinguish their projects from the hundreds of other cryptocurrencies in existence, anonymous privacy cryptos are a growing segment of the crypto market. The most known anonymous privacy cryptos in 2018 are PIVX, Dash, ZCoin, Verge, ZCash and Monero. We will also touch briefly on platform coin Komodo.

Bitcoin

Bitcoin is easily the most popular and most recognized cryptocurrency. It has established its position as the most widely held cryptocurrency with the highest value per coin and largest market capitalization. It introduced the concepts of virtual currency and encrypted digital blockchain transactions to mainstream economies. Although it is not specifically anonymous, it is somewhat resistant to financial regulations as well as control by a single entity, group or government. Bitcoin has led the move away from financial transactions that require intermediaries to pure peer to peer transactions without involving third parties to manage the transfer of funds.

Bitcoin gives us a clear glimpse of what future financial transactions will look like. Bitcoin has some drawbacks though. To mine bitcoin and maintain the transaction ledgers, complex algorithms need to be solved for earning bitcoins. Solving these complex algorithms becomes more difficult over time based on the original protocol and the supply of newly created virtual currency is decreasing. The massive energy requirement of the bitcoin network has recently been at the top of a lot of people’s concerns.

However, we will focus this article on the lack of privacy and anonymity when transacting with bitcoin. The bitcoin ledger is public, immutable and searchable. Depending on methods used to acquire and store bitcoin, it is a simple process to match a bitcoin address or transaction to an individual or entity. Bitcoin owners in countries with oppressive governments or stringent financial restrictions may discover their activities are not anonymous or as private as they desired. As a result of privacy and anonymity issues of bitcoin, many new virtual currencies are rapidly appearing that aim to solve the issues of fungibility and privacy with new approaches.

If privacy is a main concern for an investor or consumer paying with cryptocurrency, Monero should be given strong consideration. Monero was specifically designed up front to be a private anonymous currency. Every Monero transaction is fully anonymous, private and secure. Balances cannot be tracked. Transactions cannot be traced. Identities of the sender and recipient are unknown and the transaction amounts unrecorded. No authority can mandate that records be revealed because they cannot be recreated from the blockchain; legal requests for information will be unsuccessful.

The underlying technology of Monero is a complex cryptographic on-chain method. The technologies used are Kovri and Steath addresses, RingCT and the Ring Signatures. The main intent of using these technologies is to protect user privacy. Transactions made on the Monero chain appear to be mixed with other transactions and seem to come from multiple random addresses and display as multiple random amounts in order to keep prying eyes from tracing the individuals and amounts involved in each transaction. Some of the benefits that Monero offers by using these technologies are:

Privacy: no other party can look at the amount or balance of other individuals by evaluating the blockchain. Values are mixed.

Secure: the technology of irreversible cryptographic math helps to secure the wallets and transactions of Monero

Untraceable: the transactions of Monero cannot be tracked on the blockchain due to mixing and encryption

Decentralised: in order to verify Monero coins, all wallets and nodes are equally prioritized

Fungible: irrespective of the place and time, all the coins of Monero have similar market value and unknown prior transaction history.

Monero’s market debut followed generally accepted crypto standards as there were no insta-mines or pre-mines during its launch. One weakness of Monero is that the complicated cryptography and coin pooling used makes the size of the transactions very large. Thus one near-term goal of the Monero team is to update the technologies to make the transaction size smaller. Mining of Monero was deliberately made less resource-intensive than bitcoin by ensuring no specific ASIC mining equipment is needed. Monero mining algorithms run only slightly slower on standard PC’s when compared with ASIC technology, unlike bitcoin which benefits large server farms using ASIC equipment. The team expects this approach will increase the accessibility of Monero and therefore improve interest in the currency. One final criticism often leveled against Monero is the lack of ease of use of the desktop wallet. For more mainstream adoption, wallet access and interface will have to improve.

Zcash is similar to Bitcoin as it is a peer-to-peer cryptocurrency. Supply is limited to the same 21 million total as bitcoin. However, its main difference is that gives an option to focus on transactions that are fungible, anonymous and private; features missing from bitcoin. Users can choose to transact on a standard public ledger, or they can opt to keep sender, recipient and amount private. In order to become anonymous, Zcash uses a unique approach. The technology that is used by Zcash is the zk-SNARK protocol. This protocol is also referred to as Zero-Knowledge Proof. According to the Zcash team, this technology allows the network to maintain a secure ledger of balances without disclosing the parties or amounts involved. Instead of publicly demonstrating spend authority and transaction values, the transaction metadata is encrypted and zk-SNARKs are used to prove that nobody is cheating or stealing.

However, the protocol of zero-knowledge proof is not completely implemented by Zcash as their default protocol. Implementing the zero-knowledge protocol as a default program is the near term plans of Zcash. Due to the absence of this protocol as a default, there is still a public ledger or blockchain that makes it similar to Bitcoin. Only a small percentage (4%) of Zcash transactions used the private zk-SNARK protocol as of the end of 2017, and most wallets don’t support the shielded private Zcash coins.

For those interested in a deeper look into the technology behind Zcash, this article thoroughly covers the underlying tech.

PIVX (private instant verified transaction) forked from the Dash chain in 2016. It is a decentralized and open source system with focus on anonymity, security, privacy as well as cheap instant transactions. The method of achieving privacy with PIVX is to improve PoS based on the zerocoin protocol. The goal of PIVX is to create a anonymous transaction system based on proof of stake that combines privacy with hyper-fast transaction speeds. It offers a superfast transaction to try and separate itself from other anonymous coins. Since this crypto has just recently hit the markets, it is facing a number of challenges in order to get established. The near term plan of the team is to address these issues as quickly as possible.

In the privacy cryptocurrency world, Komodo can be referred to as both a privacy coin and also a platform for building privacy apps and tokens. This cryptocurrency has not yet reached the level of recognition of other coins, but the team is pinning its hope on the unique nature of an anonymous private platform for crypto development. The underlying tech is built on open source code using the zero knowledge proof and will be implementing lightning network and atomic swaps for rapid micro-transactions. This helps make transactions fungible, private, anonymous as well as transparent. It also uses the Bitcoin blockchain in order to ultra-secure the transaction system. Anonymous smart contracts will also be possible on the Komodo platform.

You can read a lot more about Komodo’s tech on their site. Komodo has forked off from Zcash in order to offer better algorithm proofs to make the security stronger. Thus in case of private transactions, Komodo is facing the same problems and limitations that the Zcash cryptocurrency had faced.

Another anonymous cryptocurrency that is unique in its nature is Zcoin. This cryptocurrency has implemented the commonly copied Zerocoin protocol, which is used for anonymous transactions. The technology used by this cryptocurrency is a parallel sub blockchain that is being linked with the main blockchain in order to become private. The obfuscation implemented by Zcoin server has just reached the point where the network is ready for prime time use. Zcoin claims to be more anonymous than bitcoin and other privacy coins because the address mixers used by those only consider small numbers of random addresses per transaction, theoretically allowing one malicious address to expose the owners of the other transactions. Zcoin claims to be able to allow many thousands of transactions per block without compromise of user data. The near-term plans of Zcoin are to integrate ethereum transactions into their Znodes and enable encrypted communication between nodes. This strategy will help Zcoin further decentralize as well as to distribute the coins in a more effective manner thus making them successful.

Dash is arguably the most well known and used anonymous privacy crypto, perhaps challenged only by Monero. Dash offers several methods of transacting. InstaSend allows for rapid public transactions. For anonymity, coin mixing is performed by the masternodes of Dash, and that results in private anonymous transactions known as PrivateSend. The technology used by Dash combines multiple inputs of identical amounts into one transaction that then has multiple outputs. PrivateSend transactions are limited to no more than 1000 Dash. The Dash network differs from other blockchains in that miners running nodes are responsible for creating new blocks and confirming transactions while a masternode model is used for governance, and masternodes perform the InstaSend and PrivateSend transactions. Masternodes must maintain a minimum of 1000 Dash to remain masternodes. Although Dash is required to comply with the same AML and KYC regulations as other cryptocurrencies, PrivateSend will effectively remain anonymous by excluding any identifying data with transactions.

Verge has an interesting history and controversial story. Created as a 2016 rebranding of 2014’s DogeCoinDark, Verge bases its privacy on use of TOR which allows connections via multiple anonymous layers and random node relays between connections to hide location and I2P which allows hidden private servers to run on a network. Verge integrates peer-to-peer transactions on Telegram, Discord, IRC and Twitter while promising Reddit and Slack integration soon. It is a tip-bot currency on those platforms for rewarding valued content creators. The currency project is open source and involved no pre-mine or ICO. Using something called the Wraith protocol, Verge allows rapid transactions and claims low costs. Users can choose between public and private anonymous transactions.

Verge has seen its share of criticism and controversy. Despite claiming that the Wraith protocol uses TOR and I2P to ensure anonymity, the team has not responded to requests to further explain how their tech works. Instead, they refer questions to their “black paper.” Verge’s stealth addresses hide the receiver of transactions, but the sender information and amounts remain publicly available. Readers are invited to review this critical article about Verge and this Medium blog response to draw their own conclusions.

April 18, 2018 update: XVG price manipulation accusations flew everywhere on social media when large block of coins was moved for sale just before a partnership between Verge and PornHub was announced April 17th. More controversy for a coin already clouded by past controversy. XVG price rose rapidly before the announcement and then quickly lost ground afterwards.

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Why use anonymous privacy cryptos?

The use cases of cryptocurrencies have grown rapidly over the past 5 years, but in practical terms there is a long way to go before widespread adoption will be seen. Many regulatory agencies and government entities point to privacy coins as potential enablers of criminal activity and tax evasion. However, there are many legitimate reasons for individuals to want financial privacy. The lack of transaction transparency is not in and of itself an indicator of a suspicious activity. Plenty of legal cash transactions occur around the world on a daily basis. If you withdraw $500 from your bank, no one tracks you to determine what the money is used for. Perhaps a buyer wishes to purchase a gift for a loved one, and doesn’t wish to use a credit card or write a check to avoid ruining the surprise. Carrying a large amount of cash can be risky, but paying with Monero or Dash could be a perfect way to transact.

Consider a successful vendor who wishes to accept privacy currencies to prevent becoming a target of thieves who might note a high balance of funds in bank accounts and mark him for a financial attack. A wealthy investor may wish to invest in or add to an investment in certain assets without drawing unnecessary attention to the purchase until it is complete or unless legal disclosure is required. When a successful investor makes a financial move, others may quickly follow causing a temporary spike in the price of the underlying asset before the investor can complete the purchase. Using privacy currencies and anonymous transactions, the initial investor can prevent that. Financial data may also be used for discrimination or for different treatment of individuals due to personal biases. Anonymity precludes that. As you can see in this bar chart, a poll of US voters about privacy expectations indicated that nearly half of respondents believe payment data should not be collected. The chart is sub-divided by political party affiliation which is not relevant to this article.

There are many foreign nationals legally living and working in the United States and other countries who regularly send portions of their earnings overseas to their families to help support them. Cryptocurrencies can aid this family support, but some governments of those countries block or even illegally confiscate cross border money transfers. By using privacy coins, the sender can increase the chances that family gets the financial help they need while avoiding corrupt government officials who have other intentions for that money. Co-author Cryptopic recently had informal discussions with employees of two cruise ship lines operating in the US and throughout the world about this very topic. Many use MoneyGram and Western Union, and they often pay high fees due to a lack of competition in the market. Many seemed very receptive to the possibility of using anonymous private cryptos to send money to families overseas to lower regulatory risks and transfer fees. Conversion back to fiat on the receiving end seemed to be their biggest concern however. This was not a scientific or formal poll.

Private anonymous cryptocurrencies provide consumers with another tool to wrest control of their money from banks, corrupt governments, and thieves. However, users need to keep in mind that when buying privacy coins, they must take precautions to make these acquisition transactions difficult to trace or match to identities. It would be of no value to buy bitcoin on an exchange, use that bitcoin to buy Monero and send that to another user who then converts it back into fiat currency on another exchange. That type of transaction is just slightly harder to trace than a straight bitcoin transfer.

Coming government regulation and tax crackdown

Even the most progressive forward-thinking world governments sometimes create policies that are difficult to understand and even harder to encourage compliance. Consider the current US tax status of cryptocurrencies. Since the 2014 IRS statement declaring cryptocurrency as investment property rather than as transactional currencies, buyers have been expected to pay capital gains taxes whenever selling or using crypto if value has increased since purchase. This certainly makes sense when buying an asset to hold as an investment, much like stocks, bonds and real estate. However, those who obtain crypto and then use it to buy goods or services are also expected to record the cost basis at the time of purchase and current value at the time of use, and then pay taxes on any gains. This becomes almost impossible when considering the purpose of crypto is to become a currency for global purchases. Can you imagine the record-keeping nightmare of having to calculate how much you paid for bitcoin each time you buy groceries, gasoline, snacks, movie tickets, or any number of other purchases?

At least some in Congress recognized the absurdity of that, which led to introduction of the Cryptocurrency Tax Fairness Act in September 2017, and we updated in November 2017. However, the bill was not incorporated into the 2018 tax plan. The lack of reasonable approaches to crypto tax could further drive crypto investors to investing in and using privacy coins as a way to avoid taxes altogether. Governments would do well to proactively pass reasonable legislation that citizens are likely to follow rather than to try and enforce policies with extremely difficult adherence even for a well-intentioned and knowledgable populace.

So to summarize, private anonymous cryptocurrencies seem to be gaining attention from mainstream consumers rather than the criminal element often associated with them. As governments attempt to introduce more restrictive regulation and implement complicated tax structures that not only penalize consumers who pay for goods and services with cryptocurrencies but also force employing expert help to ensure compliance, we should expect not only growth in the privacy coin sector but also acceleration of technical developments increasing anonymity for users leading to increased adoption. Governments and regulators should take heed of the messages behind the rise of anonymous private cryptos. Crypto investors should watch regulatory efforts closely, because any tightening will likely lead to greater interest in at least the most traded anonymous privacy cryptos and subsequent price increases. We here at TCF are bullish on this sub sector of cryptocurrency for this reason.