What is a Privacy Coin?
What is a privacy coin?
A privacy coin is a type of cryptocurrency that use technologies to make it very difficult to link an individual to a transaction providing anonymity to parties involved and confidentiality of details of the transaction like the amount.
Contrary to popular belief, most cryptocurrencies including Bitcoin do NOT provide anonymity. As part of its design, transactions that are recorded on a blockchain are public.
Transactions occur between wallet addresses (which are just a string of letters and numbers linked to your crypto wallet).
If you’re not familiar with the concept of “wallets” and “addresses”, please read my Beginner’s Guide to Bitcoin Wallets.
Depending on the cryptocurrency, the information recorded on the blockchain can include details like both the sender’s and recipient’s wallet addresses and the transaction amount.
For example, whenever a Bitcoin transaction happens, everyone and their mamas can see that the ownership of BTC has moved from one Bitcoin address to another Bitcoin address.
If someone sends you BTC at your Bitcoin address, since an address is public, anyone can see how many BTC you received.
When you want to send BTC to others, they have to give you their Bitcoin address, and once you know that, you can find out how many BTC they already have stored at that address (using a block explorer).
Theoretically, since the only information shown about a sender or receiver are their wallet addresses, which again, are just a string of letters and numbers, you don’t know their actual identities.
But IF a Bitcoin address can be linked to the person behind it, since the blockchain is a public ledger, you’ll be able to know the person’s entire transaction history and the amount of crypto currently owned.
If even one address is tied to a specific person, other addresses in that group of transactions on the blockchain can be associated with that very same person.
For example, the Bitcoin address of Satoshi Nakamoto is publicly visible and heavily monitored. You can see all the bitcoin the address has received (millions!) and sent (none).
If he/she/they ever decides to send bitcoins from the address, the entire world will know. And just like whenever Kendall Jenner gets a new boyfriend, the spotlight will now be on both addresses: Satoshi’s and the recipient’s.
These days, it’s not hard to link a person’s identity to a wallet address. If you’re using a centralized cryptocurrency exchange (CEX), you’re required to go through a Know Your Customer (KYC) process, which reveals your identity to the exchange.
Also, there are companies specializing in blockchain analytics, like Chainalysis or CipherTrace, that create tools that can analyze transactions and identify the parties involved.
There are folks in the crypto community who think Satoshi’s original blockchain design provides too much transparency, so privacy coins were developed to fix this “flaw”.
What is a privacy coin?
As the name suggests, a privacy coin heeps the user’s identity and other transaction data…private.
Privacy is the ability to keep your identity and activity from being seen by others.
Privacy coins, also referred to as “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 example, the buyer and sender of a transaction will know the amount transacted and the parties involved (themselves), but the same information will be unavailable to anybody else.
This allows users to maintain their anonymity and hide their transaction activity.
In order to be completely anonymous, it has to be impossible to link the different transactions that were done by the same person.
Not all privacy coins provide the same level of privacy and vary in their degree of anonymity
How do privacy coins work?
Given enough time, it’s possible to be able to link your wallet address with your identity and see how much crypto you own since it’s all public record on the blockchain.
With privacy coins, this would be much more difficult to do.
Privacy coins typically provide privacy in two ways.
- Provide anonymity to conceal the identities of people behind transactions.
- Provide untraceability to prevent outside observers from following a transaction trail.
Privacy coins use various methods to make their users anonymous and their transactions untraceable, such as using one-time “stealth” addresses and “mixing” multiple transactions together to create a single transaction.
What are popular privacy coins?
Let’s take a look at some of the more popular privacy coins.
Dash (DASH)
Based on Bitcoin’s source code, Dash launched in 2014. Its original name was “Xcoin“, then rebranded as “Darkcoin“, to highlight its privacy and anonymity features, and then rebranded again as “Dash” which is based on the shortened spelling of “digital cash“.
I guess “Digiash” didn’t have as nice of a ring to it. 😂
Dash uses a method known as “CoinJoin” (branded as their “PrivateSend” feature) that offers privacy by shuffling your Dash with other users, making it difficult to identify your specific transaction and trace your transaction history.
Your transaction amount is broken down into standard denominations. These denominations are 0,01 Dash, 0,1 DASH, 1 DASH and 10 DASH. Then the transaction is “mixed” with transactions from two other users that want to send the same amount. This process happens in the background without any intervention on your part.
Even though DASH claimed to be “the world’s first privacy centric crypto-currency” in the past, they now seem to be distancing themselves against the “privacy coin” label. Rather than optimize for privacy, their focus has shifted to speed and usability to become a currency used for everyday transactions.
Monero (XMR)
Monero is considered the most proven and trusted privacy coin today, so it’s no surprise that it’s also the most popular and largest privacy coin.
Launched in 2014, Monero is based on Bytecode, an earlier privacy-focused coin that was abandoned by its community for Monero when it was discovered that Bytecode developers were allegedly doing some shady things.
Monero relies on r several different technologies that work in tandem to provide privacy:
- Ring signatures (obscures the true sender by mixing their identity with decoy identities)
- Stealth addresses (ensures only the sender and receiver know a payment’s destination)
- RingCT (hides the transaction amount)
- Dandelion++ (makes it hard to link a transaction to an IP address)
Monero makes transactions unlinkable and untraceable and hides the identities of both the sender and receiver, along with the transaction amounts being transferred.
Zcash (ZEC)
Launched in 2016, Zcash is another privacy coin based on Bitcoin’s source code. But with improvements based on Zerocoin, a privacy protocol originally designed as an extension to the Bitcoin protocol that would improve Bitcoin transactions’ anonymity.
Zcash seeks to be a better alternative to Monero by ensuring transactions remain confidential while also allowing people to selectively share address and transaction information.
Zcash uses two types of addresses:
- T-address
- Z-address
A T-address (or “transparent address”) is similar to a Bitcoin address.
In a transaction between two T-addresses, the transaction works just like a Bitcoin transaction. The sender, receiver, and transaction value are publicly visible
A Z-address is fully private (or “shielded”) and uses a novel form of cryptography known as zk-SNARKs to shield transactions and conceal the sender’s identity.
In a transaction between two Z-addresses, you can identify that a transaction occurred at a certain time on the blockchain, but you don’t have any information on who participated in the transaction and how much money was involved.
Zcash transactions are not automatically made anonymously. It’s an optional feature. There are four different types of transactions with varying levels of privacy to choose from.
Others
Other privacy coins have appeared such as Secret (SCRT), Oasis Network (ROSE), Decred (DCR), Horizen (ZEN), and Keep Network (KEEP).
But they are all still relatively new and increased adoption by users remains to be seen.
Are privacy coins legal?
Government regulation on privacy coins has grown over the years.
The legality of privacy coins varies depending on the country.
Some countries perceive privacy coins as an outlet for money laundering or terrorist financing and have outright banned them, while others have left them in a legal gray area.
For example, in the U.S., privacy coins are legal. But in South Korea and Japan, trading (and holding) privacy coins are illegal.
Privacy coins are now on the U.S. government’s radar since they believe they undermine anti-money laundering controls used to detect suspicious activity by financial institutions. Privacy coins were even given a fancy name, “anonymity enhanced cryptocurrencies” or “AECs”.
Even in countries where privacy coins aren’t banned, many centralized exchanges have been pressured by regulators to delist privacy coins so their customers can’t trade them.
Listing privacy coins risk being fined or even shut down, so you’ll find them on fewer exchanges nowadays
So if you can’t find Monero (XMR), Zcash (ZEC), or Dash (DASH) on your crypto exchange, now you know why.