12.2 min read
What you should know about Privacy Coins
Written byEdna Buckley
November 28, 2022
- Anyone with sufficient resources to conduct a chain analysis can reveal the real identity behind a public address in a public blockchain.
- Privacy coins keep users' identities and other transaction data private.
- The top 3 privacy coins are XMR, ZEC, DCR.
- Anonymity will remain in demand for years to come, which could give privacy coins a brighter shine.
- In the meantime, potential investors should keep a close eye on regulatory developments in most major countries, especially the US.
- Some countries are quite open to privacy coins, while others take a hammer approach to privacy coins.
Cryptocurrencies such as Bitcoin and Ethereum are the most popular of their kind, and a key selling point is the level of anonymity they offer. However, these coins are not privacy coins as some investors believe. The open-source nature of blockchain technology allows Bitcoin transactions to be fully disclosed through the technology’s distributed ledger, not to mention the “know your customer” policies implemented by most exchanges.
Bitcoin offers in some ways less privacy than fiat currencies because it is designed to exist on a public blockchain. This further means that anyone with sufficient resources to conduct a chain analysis can reveal the real identity behind a public address. But what happens if someone wants to trade cryptocurrencies completely anonymously? Well, this is where privacy coins are most useful.
Now, privacy coins are similar to traditional cryptocurrencies, but with a unique feature: They hide wallet addresses and obscure information that can be used to trace anything back to the wallet owner. Due to its controversial nature, the asset class has since attracted many investors as well as draconian governments.
Regardless, there are over 90 privacy coins traded today to meet every investor’s key needs, with the top 3 by market cap being Monero (XMR), Zcash (ZEC), and Decred (DCR). That being said, this article will cover what privacy coins are, how they work, legality and regulation, and what potential investors should be aware of. let's start!
What are privacy coins?
The answer lies in the name itself. Privacy coins keep users' identities and other transaction data private. Let's dig a little deeper.
A privacy coin, also known as a "private coin" or "anonymity coin", is a cryptocurrency that hides all information that can link an individual to a transaction, as well as other information such as transaction amounts and current account balances in the wallet addresses.
For example, the buyer and sender of a transaction know the transaction amount and the parties involved (themselves), but no one else has access to this information. This allows users to remain anonymous and hide their trading activities.
For complete anonymity, it must be impossible to link different previous transactions by the same person. However, not all privacy coins offer the same level of privacy as they vary in their level of anonymity. So how exactly do privacy coins work?
How do privacy coins work?
Privacy coins are not much different from regular cryptocurrencies. For example, they still rely on public ledgers, and you can still see transactions happen, but you can't easily track wallet addresses.
Governments and others who may want to trace the origin of transactions say privacy coins hide the flow of money on their networks from the public. They do this by keeping important information involved in the transaction (e.g. wallet address, transaction amount, sender and receiver wallet addresses, etc.) away from the public.
If you send your private coins to a different address, other users will not be able to access the details of the transaction. However, there are many privacy coins on the market, many using their methods to ensure anonymity, each with varying degrees of success. Here are the three encryption techniques used by some privacy coins:
- Stealth address: Each transaction will generate a new address to protect the privacy of the payee.
- Zk-SNARKs: Zk-SNARKs, an acronym for zero-knowledge, concise non-interactive proofs of knowledge that allow you to prove that a transaction is valid without sharing its details (sender, receiver, amount).
- Ring signature: When you sign a transaction with your private key, others can link your signature to your address. Ring signatures prevent this. With different signatures on the same transaction, it is difficult for others to link your signature to your address.
Pros and Cons of Using Privacy Coins
Many investors prefer privacy coins as a better alternative to Bitcoin and other public cryptocurrencies. One notable reason for this is anonymity in transactions. However, despite their great advantages, privacy coins also have their disadvantages.
Benefits of Using Privacy Coins
Privacy coins are attractive to investors who want anonymity. While the public ledger aspect of blockchain technology is useful, it won't suit every investor's needs. Privacy coins guarantee that users can transfer any amount to anyone without verification. With vast amounts of personal information becoming a commodity, many people value privacy above all else.
2. Financial Security
Privacy coins do more than protect identity; they also prevent a person from being targeted by governments and corporations. For example, it is possible to examine companies or individuals that have significant transactions with customers, competitors, or hackers. Anonymity prevents the public from knowing who is involved in a transaction or how much it costs.
Disadvantages of Using Privacy Coins
1. Higher transaction fees
Privacy coin transactions have all these additional features, which means that transaction fees are generally higher, which also translates into higher gas fees.
2. Illegal activities
Privacy coins can be used for illegal activities; in addition to their general use of buying illegal goods on the black market, they can also be used for money laundering or tax evasion.
3. Government Prohibition
Because of all the ways privacy coins can be misused, some countries have banned their use. Every time a country bans a privacy coin, its price can plummet, a move that could hurt investors.
The Legality of Privacy Coins: Why Are They So Fussed?
Well, the legality of privacy coins depends entirely on the context or jurisdiction in which they are being discussed or used. Some countries are quite open to privacy coins, while others take a hammer approach to privacy coins. For example, South Korea banned the trading of privacy coins on the country’s crypto exchanges to curb money laundering.
Japan is no exception. The country has imposed a ban on all cryptocurrencies that provide sufficient anonymity, with Japan’s Financial Security Agency (FSA) stating that the main reason for the ban is to prevent illegal activities in the cryptocurrency market.
In Australia, cryptocurrency exchanges have delisted privacy coins amid regulatory and banking pressure. Blockchain analysis firm Chainalysis is believed to have played a major role in the decision-making in Australia and other countries. Likewise, the Financial Action Task Force (FATF) has listed privacy coins as potential red flags for money laundering through virtual assets.
However, countries that have not banned private coins have not supported them either. Privacy coins are legal in the U.S., but the Secret Service recommends that Congress regulate private-enhanced cryptocurrencies.
What is the future of privacy coins?
Privacy coins have powerful uses, and their inherent ability to enable more discreet transactions on the blockchain is not going away anytime soon. While it's uncertain for them in terms of regulation, they offer what many crave, financially and otherwise, which is anonymity.
Trading platforms that delisted privacy coins like Dash (DASH), Decred (DCR), Firo (FIRO), and Monero (XMR) certainly made it harder for ordinary investors to acquire or use them. But some peer-to-peer marketplaces and anonymity-focused trading venues will be happy to facilitate the use of BTC and other digital assets in XMR.
The future of privacy coins appears to be a bit unclear, which may reduce the number of people speculating on them. However, people who need privacy will still find ways to buy privacy coins. Anonymity will remain in demand for years to come, which could give privacy coins a brighter shine.
What about investors?
Investing in privacy coins may be risky now, but they are not going away. They may become mainstream at some point, just like Bitcoin. Finally, privacy coins, like any other cryptocurrency, have an extra layer of security and privacy.
In the meantime, potential investors should keep a close eye on regulatory developments in most major countries, especially the US. In general, cryptocurrencies have always been subject to regulatory risk, which you should consider when deciding to invest in privacy coins.
Why you should care
Privacy coins have come a long way since 2014. While they have recently found success by offering investors true anonymity, they have also faced hurdles related to illegal activities. However, privacy coins have a future as long as everyone in the world wants data protection and privacy.
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