What are Privacy Coins?

A privacy coin is a specific type of cryptocurrency that aims to provide greater anonymity to its users. It uses advanced technologies to make it difficult for anyone to link a particular individual to a transaction.

This means that parties involved in the transaction can remain anonymous, and the transaction details, such as the amount, are kept confidential.

Despite what many people think, most cryptocurrencies, including Bitcoin, do not offer complete anonymity. This is because blockchain transactions are public and recorded for anyone to see.

In cryptocurrency transactions, funds are moved between different wallet addresses, essentially a string of letters and numbers linked to your digital wallet.

Key takeaways

• Cryptocurrencies use sophisticated encryption and privacy features to keep users’ profiles a secret. However, it’s unlikely that complete anonymity can be guaranteed due to blockchain transactions being public records.
• There are ways to obscure your identity or transaction history on Bitcoin, such as using the cryptocurrency mixer CoinJoin. However, this requires some technical knowledge and comes with transaction fees.
• Privacy coins are a new type of cryptocurrency that offer advanced cryptographic methods to distinguish themselves from Bitcoin and other altcoins. They’re an emerging asset class that aims to provide greater anonymity to users.

How do privacy coins work?

Privacy coins may seem similar to coins like Bitcoin if you remove the privacy-preserving technology. They both use blockchains, decentralized book-keeping systems maintained by a global network of unknown validators.

However, it’s the top-notch privacy techniques that distinguish privacy coins apart from the rest. Some privacy coins are private by default, while others allow users to choose their privacy settings.

When the privacy setting is activated, several mechanisms come into play to make users such as yourself and the transaction private.

Zero-Knowledge Proofs

Zero-knowledge proofs, also known as ZKPs, are cryptographic techniques that allow someone to prove the existence of something without revealing its true nature.

Privacy coin Zcash, for instance, employs ZKPs to safeguard users’ privacy. A specific example of a ZKP is zk-SNARKs, which stands for “zero-knowledge succinct non-interactive argument of knowledge.”

This technique is considered to provide extremely strong privacy protection.

Masking

According to Gotslak, privacy coins use a process where they replace the initial transaction code with a new code.

This method removes the transaction from the original sender’s identity, providing users with greater anonymity.

Ring Signatures

Ring signatures are a unique collection of many real signatures, but only one belongs to the person who executes the transaction.

This means the user’s identity is concealed within a group of decoys, making it harder to trace the transaction. Monero, a privacy coin, utilizes ring signatures and introduced Ring Confidential Transactions, or RingCT, in 2017.

This technology doesn’t require any trusted setup. It effectively hides the identity of both the originators and recipients, as well as the amount of the transaction, according to a white paper on the topic.

Stealth Addresses

Stealth addresses conceal a user’s public key and the transaction amount, but they do not conceal information about the product or service purchased, including the quantity.

They’re commonly used by individuals who wish to keep their donations to non-profits anonymous and those who want to avoid taxes.

Uses of privacy coins

Privacy coins are particularly valuable in certain cases because of their difficult-to-trace nature. For instance, suppose you operate a business and need to handle cryptocurrency payments to and from your suppliers.

If you used a Bitcoin wallet, your suppliers could see the amount of money you have in your account, potentially giving them leverage to negotiate better contract rates.

Similarly, suppose you wanted to trace the ownership history of your cryptocurrencies and discovered that some of your Ethereum had been involved in criminal or fraudulent activity.

In that case, you could end up in legal trouble if investigators traced the tainted cryptocurrency back to your wallet. With privacy coins, this risk is eliminated since they are untraceable.

Your transaction history is publicly available when using traditional cryptocurrencies, such as Bitcoin.

This means that e-commerce vendors could analyze your wallet and adjust prices according to your spending habits, creating privacy concerns. Privacy coins avoid this issue by keeping your data confidential.

The fungibility quality of privacy coins is also crucial since it ensures that all coins are interchangeable and indistinguishable.

However, this quality also makes privacy coins attractive for illegal transactions such as money laundering or purchasing illegal goods and services.

This ability for illicit use has resulted in many jurisdictions banning privacy coins.

Are privacy coins legal?

Privacy coins are facing increased scrutiny from regulators worldwide as authorities try to combat illicit activities facilitated by these coins.

The legal status of privacy coins varies depending on the country, with some viewing them as a tool for money laundering or terrorist financing, resulting in a complete ban.

Others, however, are still operating in a legal grey area. For instance, Australia and South Korea have prohibited exchanges from providing privacy coins, while Japan has banned them entirely.

With the imposition of “know your customer” regulations by anti-money laundering regulators, privacy coin users may face further challenges.

These regulations include the FATF Travel Rule and the AMLD-5 directive set by the European Union.

Are privacy coins really private?

Because privacy coins are continuously being tested and new technologies are being developed, it is challenging to classify them as private.

New tools could be created that would break modern encryption methods. However, with the current cryptographic techniques, privacy coins have demonstrated their ability to remain secure.

What are popular privacy coins?

Dash (DASH)

Dash is a cryptocurrency launched in 2014 based on Bitcoin’s source code. Originally named “Xcoin”, it was rebranded as “Darkcoin” to highlight its privacy features before being renamed again as “Dash” to reflect its focus on becoming digital cash.

Dash offers privacy through its “PrivateSend” feature, which uses “CoinJoin” to shuffle your Dash with other users, making it difficult to trace your transaction history.

The transaction amount is broken down into standard denominations and then mixed with transactions from two other users who want to send the same amount without requiring any intervention on your part.

Although Dash was once labeled “the world’s first privacy-centric crypto-currency”, it seems to be distancing itself from the “privacy coin” label.

Rather than focusing on privacy, Dash now prioritizes speed and usability to become a cryptocurrency for everyday transactions.

Monero (XMR)

Monero is the most popular and largest privacy coin around, and for a good reason. It’s been around since 2014 and is built on the foundation of an earlier privacy coin called Bytecode.

Monero uses several technologies in conjunction with one another to provide users with unmatched privacy.

Ring signatures mix the true sender’s identity with fake ones, making it difficult to determine the true sender. Stealth addresses ensure that only the sender and receiver know the destination of the payment while the amount is hidden.

Additionally, Dandelion++ makes linking a transaction to an IP address hard. As a result, Monero transactions are unlinkable and untraceable, and the identities of both the sender and receiver remain hidden, as well as the amount being transferred.

Zcash (ZEC)

Zcash is a privacy coin launched in 2016 based on Bitcoin’s code with added improvements from the Zerocoin privacy protocol.

Zcash strives to offer a better option than Monero by maintaining confidentiality while allowing users to share address and transaction information selectively.

Zcash has two types of addresses: T-address and Z-address. T-address works similarly to Bitcoin, where the transaction details are publicly visible.

However, a Z-address is private and uses zk-SNARKs cryptography to shield transactions and conceal the sender’s identity. Zcash transactions don’t automatically occur anonymously but are an optional feature.

There are four transaction types with varying levels of privacy to choose from.

Polkadot with Phala

Polkadot is a cross-chain connection network that doesn’t offer privacy protection. However, a project called the Phala Network parachain has been added to Polkadot to provide confidential features to its data transfers.

According to the project’s supporters, privacy protection is an important aspect of the Web3 vision, where Polkadot acts as the digital connector linking multiple blockchains.

It’s a logical step, given that the system aims to empower individual users to make connections and transactions without the need for intermediaries or third parties.