Privacy coins, as their name implies, are a category of cryptocurrencies designed to provide users with transactional anonymity. These coins aim to make it challenging to trace and identify the parties involved in a transaction. This feature can be beneficial for individuals seeking to protect their financial activities from prying eyes.
For example – in August 2022, the US Treasury Department banned users from using Tornado Cash. We wrote about how cryptocurrency mixing facilities work here.
So, what are privacy coins? Today we will try to find the answer to this question.
Privacy Tokens / Privacy Coins – Definition
Privacy coins are often classified as a subset of cryptocurrencies. They are designed to maintain complete user privacy by cloaking a particular monetary transaction. With such cryptocurrencies, no one will be able to track your financial transaction.
Privacy Coins make it very difficult to trace the sender as well as the recipient of a particular transaction.
The aforementioned ban on Tornado Cash has stirred up controversy. Regulators felt concern about the use of fully anonymous cryptocurrencies, or mixers. Hardly surprising – they definitely affect security and enable illegal criminal activity.
How Do Anonymous Coins Work?
Privacy Coins have a mechanism in them to protect anonymity. Once it is removed, they become very similar to other cryptocurrencies, such as Bitcoin.
They are powered by blockchain, or decentralized ledgers, which are maintained by anonymous validators. What you need to know is that this type of cryptocurrency has really advanced privacy mechanisms. This grade of privacy tokens includes Zcash or Monero, among others.
How Do Privacy Coins Work?
In the case of classic cryptocurrencies, it is very easy to associate a wallet address with a person’s identity and see how much cryptocurrency they have. All this data is simply a block on a public blockchain. With anonymous coins, however, this is certainly more difficult to do.
Privacy tokens provide anonymity in two main ways:
- They hide the identity of the person behind a particular transaction.
- They provide advanced algorithms that prevent the path of a given transaction from being traced.
How? Privacy tokens use disposable “stealth” addresses and cryptocurrency mixers to create a single transaction, impossible to detect. So you already know why they are so popular.
Anonymous Coins
- Monero
In the cryptocurrency industry, Monero is considered the most proven and trusted coin when it comes to privacy. It is also the largest cryptocurrency in the privacy tokens category.
Monero was created in 2014. It is based on Bytecode, an earlier coin that was also focused on privacy. However, the community abandoned it when indications of its suspicious activity came to light.
Monero, as a privacy token, is based on several technologies that together provide maximum anonymity:
- The Monero cryptocurrency uses ring signatures that obscure the identity of the real sender of a transaction by mixing his identity with others.
- It uses so-called stealth addresses. This is an algorithm that assures the sender and receiver that only they know the destination of a transaction.
- RingCT, which hides the amount of a given transaction very effectively.
- In addition, the Dandelion++ algorithm plays a significant role in enhancing privacy by concealing the IP address. As a result, it becomes extremely challenging to link a specific transaction to the IP address of the sender or recipient.
As you can see, Monero is great at hiding identities. Both of the sender and the recipient. When it is used, there is also no way to discover the amount that was transferred between two people.
- ZCash
This is another privacy coin, created in 2016 and running on the source code of Bitcoin itself. It offers us quite a few improvements, based on Zerocoin, the privacy protocol. It was originally intended to be an extension of the Bitcoin protocol, which was also designed to improve the anonymity of transactions on the Bitcoin network.
ZCash aims to surpass Monero by emphasizing the importance of transaction confidentiality for its users. It assures users that their transactions will remain confidential, while also offering the flexibility to selectively disclose information about addresses and transactions.
ZCash bases its operation on two addresses: T-address and Z-address. Between these two addresses, the transaction itself works much like a Bitcoin protocol transaction. Both the sender and receiver are publicly visible.
However, if this were really the case, ZCash would not classify as an anonymous coin. The Z address is fully shielded, that is, private. To do this, it uses the zk-SNARK protocol, which shields the transaction and hides the identity of the sender. We wrote about what the zk-SNARK protocol is here [LINK – WHAT IS ZKSNARK AND ZKSTARK PROOF – MASTER LEVEL].
Between the two zk addresses, we can only identify that a transaction took place. We are also able to verify the time on the blockchain at which it was made. However, we have no physical way to discover who was the sender and recipient of a given transfer. As with Monero, we also don’t know how much money was sent.
- Dash
The Dash cryptocurrency, known at first as Xcoin and later as Darkcoin, appeared in 2014. It, too, was created based on Bitcoin’s source code. The name “Dash” is based on a shortened spelling of digital cash.
Dash bases its operation on the CoinJoin method. It is labeled “PrivateSend” in the algorithm of this private token. It offers privacy by shuffling the sent Dash with other users. Thus, it makes it difficult to identify our specific transaction and track its history.
How else does Dash work? It divides the entire transaction amount, into smaller denominations of Dash, 0.1 Dash, 1 Dash, and 10 Dash. Your transaction is then mixed with those of other users who want to send the same amount as yours. The whole process takes place in the background, and you have no idea about it.
The aforementioned cryptocurrencies represent some of the most popular privacy coins currently available. However, the landscape is constantly evolving, and new privacy coins continue to emerge. Examples of relatively new privacy coins include Secret (SCRT), Horizen (ZEN), and Keep Network (KEEP). It will be interesting to observe how these new additions are received by the crypto community.
Are Privacy Coins Legal?
It is important to consider that privacy coins and cryptocurrency mixers are under significant scrutiny from authorities and regulators. Government bodies are actively targeting these technologies in an effort to combat crime and money laundering.
At this point, privacy coins have been outlawed in Japan, Australia, and South Korea. In the countries listed, their sale has also been heavily restricted.
However, answering the question posed above specifically – the legality of privacy tokens, varies from country to country.
Interestingly, even in countries where privacy tokens are not fully banned, many exchanges have been forced to remove the availability of these coins. Therefore, you will not find Monero, Zen, Dash or Zcash on every exchange.
Are Privacy Tokens Really Private?
Currently, yes. However, given the fact that analytical tools and the capabilities of computers, and therefore programs, are constantly evolving, it will be possible in the future to break the secret encryption codes of anonymous coins. For the time being, they are resistant to our ability to break advanced codes.
Summary
You already know how anonymous coins are built and how they work. What will be their future? Given the development of tools and many other factors, in our opinion, anonymous coins will cease to be anonymous in the future.
The growing involvement of regulators in the cryptocurrency market is also making an impact.