Private Cryptocurrencies Challenge Bitcoin Fungibility
Updated
https://diarweekly.com/volume-2-issue-2/#4
Private Cryptocurrencies Challenge Bitcoin Fungibility
Bitcoin and most cryptocurrencies are pseudo-anonymous – all transactions are publicaly available online including the addresses and amount being sent. As a result, the coins can sometimes be traced back to a person through blockchain analysis. Privacy cryptocurrencies the likes of Monero and Zcash are attempting to solve the problem by masking all the information about the transactions to provide full anonymity. The movements of the privacy cryptocurrencies are near impossible to track, giving governments another technical obstacle to overcome.
When Bitcoin was introduced in 2009, it launched from a premise of shifting the power from governments, central banks and corporations to individual people. As with other decentralized cryptocurrencies, the ownership is guaranteed with the possession of private keys, which makes it impossible to be seized or manipulated by a central authority.
However, most of the cryptocurrencies including Bitcoin are pseudo-anonymous. Even though the transactions are not tied directly to an identity, every transaction is recorded publicly on the blockchain, which includes the sender’s address, the receiver’s address and the amount. By analyzing the blockchain, the coins can sometimes be traced back to the identity of users by looking at the patterns of transaction history. The issue of financial privacy is not only a matter for criminals but rather for anyone who wants the ecosystem of cryptocurrencies to remain decentralized.
Blockchain forensics companies such as Elliptic and Chainalysis are already providing actionable intelligence to law enforcement and other entities to help them identify illicit activities and assist with Anti-Money Laundering (AML) compliance. These companies obtain Know-Your-Client (KYC) information that is required to be provided for all the cryptocurrency exchanges and thus have access to identifiable information.
The current solution to enhance Bitcoin’s fungibility is to use a tumbling software such as the open source JoinMarket, which automatically mixes coins of different people to obfuscate the trail back to the fund's original source. Most of the wallets generate a new address each time a transaction is received to obscure the identity which helps, but is far from perfect.
Bitcoin’s inability to provide a fully private and fungible solution has ignited the creation of other cryptocurrencies that focus mainly on privacy features.
Monero, which launched in 2014 after forking from Bytecoin, is often considered the most prominent privacy-based cryptocurrency. Monero uses stealth addresses, which means that after every transaction is made, a random single-use address is generated, and the transactions are routed through that address. Stealth addresses therefore mask a receiver, which in turn assures that there is no linkability on Monero. However, in order to be truly private, Monero also solves the issue of traceability by utilizing ring signatures. The untraceability means that the original sender of the transaction is not able to trace when or where the recipient of the transaction moves the coins. Ring signatures essentially mix the real transaction with a few other already existing transactions on the blockchain, which guarantees plausible deniability. In January 2017, Monero implemented an improved version of ring signatures called RingCT, which also obscures the amount being transacted. RingCT became mandatory for every transaction after September 2017.
Private Cryptocurrencies Challenge Bitcoin Fungibility
Bitcoin and most cryptocurrencies are pseudo-anonymous – all transactions are publicaly available online including the addresses and amount being sent. As a result, the coins can sometimes be traced back to a person through blockchain analysis. Privacy cryptocurrencies the likes of Monero and Zcash are attempting to solve the problem by masking all the information about the transactions to provide full anonymity. The movements of the privacy cryptocurrencies are near impossible to track, giving governments another technical obstacle to overcome.
When Bitcoin was introduced in 2009, it launched from a premise of shifting the power from governments, central banks and corporations to individual people. As with other decentralized cryptocurrencies, the ownership is guaranteed with the possession of private keys, which makes it impossible to be seized or manipulated by a central authority.
However, most of the cryptocurrencies including Bitcoin are pseudo-anonymous. Even though the transactions are not tied directly to an identity, every transaction is recorded publicly on the blockchain, which includes the sender’s address, the receiver’s address and the amount. By analyzing the blockchain, the coins can sometimes be traced back to the identity of users by looking at the patterns of transaction history. The issue of financial privacy is not only a matter for criminals but rather for anyone who wants the ecosystem of cryptocurrencies to remain decentralized.
Blockchain forensics companies such as Elliptic and Chainalysis are already providing actionable intelligence to law enforcement and other entities to help them identify illicit activities and assist with Anti-Money Laundering (AML) compliance. These companies obtain Know-Your-Client (KYC) information that is required to be provided for all the cryptocurrency exchanges and thus have access to identifiable information.
The current solution to enhance Bitcoin’s fungibility is to use a tumbling software such as the open source JoinMarket, which automatically mixes coins of different people to obfuscate the trail back to the fund's original source. Most of the wallets generate a new address each time a transaction is received to obscure the identity which helps, but is far from perfect.
Bitcoin’s inability to provide a fully private and fungible solution has ignited the creation of other cryptocurrencies that focus mainly on privacy features.
Monero, which launched in 2014 after forking from Bytecoin, is often considered the most prominent privacy-based cryptocurrency. Monero uses stealth addresses, which means that after every transaction is made, a random single-use address is generated, and the transactions are routed through that address. Stealth addresses therefore mask a receiver, which in turn assures that there is no linkability on Monero. However, in order to be truly private, Monero also solves the issue of traceability by utilizing ring signatures. The untraceability means that the original sender of the transaction is not able to trace when or where the recipient of the transaction moves the coins. Ring signatures essentially mix the real transaction with a few other already existing transactions on the blockchain, which guarantees plausible deniability. In January 2017, Monero implemented an improved version of ring signatures called RingCT, which also obscures the amount being transacted. RingCT became mandatory for every transaction after September 2017.
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Because of Monero’s privacy enhanced functionality, the coins are fungible. Coinfirm, a company that specializes in analyzing the blockchain to determine which coins are suspected of being involved in illicit activity, currently treats all the of Monero transactions as high risk because its privacy techniques are so established that it’s impossible to figure out its history. It only treats about 10% of Bitcoin transactions as high risk.Note
According to Riccardo Spagni, one of the seven members of the Monero Core Team (all but two are anonymous), most of the users use Monero legitimately. Of course he should have no way of knowing if that statement is true. Speaking to Bloomberg, Mr Spagni said that he wants people to have access to a fully private coin where no one knows whether they are buying a car or a coffee. He added that since Monero is decentralized, it’s impossible to prevent illicit actors from using it.Note
The closest competitor to Monero is Zcash, which was launched in October 2016. As opposed to Monero, 10% of all the supply will be distributed to the stakeholders in the Zcash Company - founders, investors, employees, and advisors (see story above). Zcash uses an advanced zero-knowledge proof cryptography called zk-SNARKs. All the transaction data is fully private including metadata, which is encrypted. Zero-knowledge proof means that the validity of data can be proved without revealing the actual data because it is secret. Therefore, there is a real concern that the total supply cannot be verified because the system is too private. If the trusted parties that are controlling Zcash were to collude and secretly create more coins, it would be impossible to tell.Another difference from Monero is that the transactions are transparent by default and optionally private. Currently, most of the transactions on Zcash are not private, which makes it easier to identify the private ones through traffic analysis. The private transactions are quite resource intensive for users as sending a private transaction takes about 3GB of RAM and an average of 40 seconds to perform the encryption, which is one of the major reasons that it's rarely used in practice. Zcash's next major upgrade, codenamed Sapling, should significantly decrease both the resource requirements and the time needed to send a private transaction. Zooko Wilcox, CEO of the Zcash Company, stated that the intent is to upgrade to all private all the time eventually. Even though the technology of Zcash is more advanced than Monero, it has yet stand out and there are still some unresolved issues.
Note
Zcash and Monero are the main privacy coins but there are also a few lesser known ones. Zclassic for example forked from Zcash over the concerns of 10% of the supply going to the stakeholders. DASH also has an opt-in privacy feature that integrates tumbling of the coins in the same block to enhance anonymity.There is also Verge, which automatically hides the IP address of the sender by routing the transaction through Tor or I2P. Most of the cryptocurrencies including Bitcoin can be used with Tor to achieve the same level of privacy that Verge provides, which indicates that Verge currently doesn’t add much value.
Zcash has the most advanced cryptography of the private transactions, which technically makes it more anonymous than Monero. However, since the transactions are not private by default, it is possible to narrow down the private transactions through traffic analysis. Monero is currently the most private coin that uses technology that has been thoroughly tested with time and all of the privacy features are turned on by default. Other privacy-based coins are either not known enough or their privacy features are far from the features that Monero and Zcash provide.
Note
Since the most private coins are impossible to track by the government and their awareness is growing, it is possible that regulators could put pressure on fiat off-ramps. In October 2017, Europol stated that “Monero, Ethereum and Zcash are gaining popularity within the digital underground” and that Monero transactions cannot currently be attributed to any particular user or address. With coins that are truly private, AML/KYC regulations at compliant exchanges can therefore only be used to determine who bought and sold how much for tax purposes but they cannot determine what is being done with the coins that were bought.
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