What are privacy coins? A guide to anonymous cryptos

These coins protect personal data, but have become associated with illegal activities

A poster for the monero cryptocurrency                                 
Privacy coins are being used to pay for illegal goods, including hard drugs, on dark net sites – Photo: Alamy
                                

Contents

There has been a growing privacy battle in the technology sector, whether among tech titans like Facebook or cryptocurrencies such as bitcoin. Users are now demanding greater confidentiality when it comes to their personal data, and privacy coins risen to fame as a result.

This category of cryptocurrency combines decentralisation with anonymity. Instead of a public blockchain, where all transaction details are public, privacy coins allow investors to send money without that personal information being made widely available.

The discretion offered by privacy coins has been misused in illegal settings, ranging from the dark net, to wash trading, right up to trading nuclear secrets. While this has led them to come under fire from governments worldwide, President Biden’s recent announcement suggested the US will prioritise privacy in any forthcoming digital asset regulation.

The coins could still be restrained in some manner by the US government, but the announcement implied that privacy coins are here to stay.

What are privacy coins?

The secret behind cryptocurrencies is the blockchain, a public database that keeps track of every transaction. This technology allows cryptocurrencies to become decentralised and avoid middlemen (such as banks) handling the funds.

However this means that, in some ways, coins like bitcoin are less private than the US dollar. Theoretically, anyone can look at the details of any and every crypto transaction. With powerful enough tools, users can uncover transaction amounts, wallet addresses, and possibly even real identities.

Privacy coins are bringing anonymity to the crypto world, allowing investors to make transactions without these details being broadcasted to the public. There are two focus points for this category of coins: hiding the identities involved in transactions, and making the transactions themselves untraceable.

How does a privacy coin work?

There are a range of privacy coins in the market, which use a variety of methods to achieve the same goals. Monero (XMR) was one of the first privacy coins, having launched in 2014, and it has since become the largest by market cap.

It partly achieves privacy by the use of stealth addresses: a one-time-only wallet address is created for every transaction. Monero’s network can therefore not be used to track identities, or to string together a trail of transactions.

Monero also employs another obfuscation tactic, whereby it uses past transactions as a decoy and splits up the actual transaction into chunks. For example, if I was sent 100 XMR, this could have been split up into two lots of 50 XMR.

Tornado Cash (TORN) is a more recent addition to the privacy coin market. Its anonymity method is different from that used by Monero. Users can deposit or withdraw tokens, but must use a “secret” or “note” to access these funds. These transactions are not linked, meaning no one is able to tell which deposit is linked to which withdrawal.

The privacy coin uses shielded addresses for these transactions. As with monero, these addresses are created specifically for each individual transaction.

Ransomware, dark net, and nuclear secrets

For those wondering, ‘What is a privacy coin used for?’, there are actually some legitimate use cases.

Technology giants have been exposed in recent years for tracking and storing huge amounts of data about their users. Privacy coins act as a way to stop any middleman from having information about your funds. A blog post gave the example of protecting your funds from corrupt politicians or thieving bankers.

However, there is a growing concern that the power given by privacy coins is being manipulated. CNBC reported that 44% of ransomware attacks in 2018 demanded payment in monero. Meanwhile, stolen ether from Crypto.com was being washed via the Tornado Cash smart contract in January 2022.

The controversy does not stop there. Privacy coins have become a popular choice for users who want to purchase illicit goods on dark net marketplaces. Monero is used as a payment choice on The Versus Project and ASAP, marketplaces that sell hard drugs, malware and other illegal products.

The US Justice Department closed down one dark net site called AlphaBay which used monero as a payment method. It said the site was a “major source of fentanyl and heroin,” drugs which have been linked to a large number of deaths by overdose in recent years.

This is not the only time the US government has been involved with privacy coins. A navy man tried to sell nuclear secrets for $70,000 worth of XMR, but his plan was foiled by undercover agents.

Regulation

It comes as no surprise that governments want to crack down on these coins, but there is a varying degree of regulation.

There are countries like South Korea and Japan that have outright banned privacy coins. While the US has not banned them outright, the cryptocurrencies have come under fire.

Robert Novy, the deputy assistant director of the Secret Service’s office of investigations, told Congress that “criminals are increasingly leveraging anonymity-enhanced currencies and services” in a 2018 testimony.

It is not just nation states that are taking a stand on privacy coins. In 2021, Bitrex and Kraken delisted monero from their exchanges. Kraken said it was responding to guidance from the UK’s financial markets regulator, the Financial Conduct Authority (FCA).

Biden’s announcement

The most recent update regarding US crypto regulation was from Biden’s digital asset announcement in March 2022. He said the Attorney General would submit a report of recommendations for law enforcement on investigating and prosecuting illegal crypto activity. However, throughout Biden’s statement he prioritised privacy as an important factor for digital assets.

The statement said: “The United States should ensure that safeguards are in place and promote the responsible development of digital assets to... maintain privacy.”

An hour and a half after the press statement, monero and zcash saw a 20% price spike. Zcash has seen this rally continue and is up 44% in the past seven days, while monero is up 14% over the past week.

Privacy coins have come a long way since 2014. The market has boomed and they are enoying recent success. But there could still be obstacles in their path: as long as they are associated with illegal activity, the coins will continue to come under fire from governments and exchanges alike.

FAQs

There are 90 different cryptocurrencies that fall into the ‘Privacy’ category on CoinMarketCap. The top three by market cap are monero (XMR), zcash (ZEC) and oasis network (ROSE).

It depends on the jurisdiction. Some countries, including South Korea and Japan, have banned privacy coins outright. The US has not banned them but there is new regulation coming that will target cryptocurrency being used for illegal activities.  

Privacy coins allow investors to keep their personal data confidential. Unlike bitcoin, which makes all transaction details a matter of public record, privacy coins hide users’ wallet address and transaction amounts.

Further reading

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