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With the increasing need for privacy, the demand for privacy coins is experiencing steady growth. After all, they offer a way for users to transact without revealing their identity.
Maintaining anonymity while participating in a crypto transaction is a big deal to many for a variety of reasons. However, with the increased scrutiny of cryptocurrencies worldwide, many are wondering if so-called “privacy coins” will survive the oncoming onslaught.
Today, we will delve deeper into the world of privacy coins to see what you can expect!
A Brief Overview
The pseudonymous nature of Bitcoin addresses allows transactions without personal information being revealed, but this does not make it an entirely anonymous cryptocurrency. While transactions are recorded in the network, origin and destination addresses are fully delinked.
Addresses may be linked to a person's identity, which poses a challenge to privacy-conscious individuals. For instance, forensic blockchain experts can easily trace publicly available addresses linked to a person's identity through analysis of transaction histories.
Although privacy coins are built upon the same blockchain technology that powers most cryptocurrencies, they take it one step further by encrypting certain information in how transactions are processed.
As such, unlike Bitcoin (BTC) and Ether (ETH), privacy coins promise increased anonymity by hiding users' addresses and transaction amounts, making transactions harder to track. The three most popular privacy coins are Monero (XMR), Zcash (ZEC), and Dash (DASH).
Monero, Zcash & Dash: How Do They Approach Privacy?
The total market cap of all privacy coins is currently about $6.2 billion, according to Coinmarketcap.
Among all privacy coins, Monero (XMR) is the largest one as per market capitalization, and the 26th largest cryptocurrency with a market cap of $3 billion, trading at $169, down 69% from its all-time high (ATH) hit five years ago.
Forked from Bytecoin in April 2014 with no pre-mine and no VC funding, Monero (XMR) anonymizes key details, such as both sender and receiver, and the transaction amount.
Based on the CryptoNote protocol, the Monero network protects user's privacy through its use of stealth addresses (a unique address created by the sender for every transaction), ring signatures (a technique using multiple signatures as decoys to confuse the sender's address), and Ring Confidential Transactions, also known as RingCTs (an enhanced version of ring signatures which conceals the amount of XMR used in the transaction).
To learn more, make sure to visit our Investing in Monero guide.
With a market cap of $574 million, Zcash (ZEC) sits at 70th place, trading at $43.5 as of writing, down 98.6% from its peak hit over six years ago.
Zcash was developed and launched in Oct. 2016 to offer improved privacy to its users. While Monero makes all transactions private, Zcash makes it optional, as it is a fork from Bitcoin, and parts of the blockchain are transparent.
It is based on the Zerocash protocol, which improves upon the Bitcoin protocol by using a unique approach to privacy called zk-SNARKs, which stands for “Zero-Knowledge Succinct Non-Interactive Arguments of Knowledge.” Zk-SNARKs is a complex mathematical protocol that allows two parties to exchange information without revealing anything about their identities.
To learn more, make sure to visit our Investing in Zcash guide
Sitting at 74th place, Dash (DASH) has a market cap of $552 million and is currently trading at $50, 96.6% off its ATH from five years ago.
Dash is a digital currency that was created in Jan. 2014. Unlike Monero, Dash is not driven by privacy alone, offering privacy protection for transactions as an option to users.
Forked from Bitcoin, Dash was created to improve upon the original cryptocurrency. To achieve privacy, Dash uses Coinjoin (called PrivateSend) to mix multiple transactions together, making it more challenging to identify details. It also has an InstantSend option for rapid transactions confirmed within two seconds.
To learn more, make sure to visit our Investing in Dash guide.
Regulation is Imminent
Privacy coins are vital as they offer a high level of anonymity for those who value their privacy. But regulators worldwide don't feel the same, as they want every transaction accounted for. They want to be able to track and trace every penny. And regulation in crypto is amping up after 2022, which saw the collapse of FTX, Celsius, BlockFi, Terra/Luna, and other platforms.
After the collapse of FTX, John Ray III, the new CEO of the defunct crypto exchange, declared that he'd never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information” as what occurred with FTX.
Meanwhile, Do Kwon, co-founder and CEO of Terraform Labs is on the run from prosecutors since the collapse of Terra earlier this year. Three Arrows Capital (3AC), the crypto hedge fund that failed to repay loans after Terra's collapse, also went bankrupt, sparking the collapse of lenders Celsius Network and Voyager Digital, leaving customer funds in the lurch and pummeling all the other companies from which 3AC had borrowed money.
Preventing another FTX-style collapse has become a top priority for every government body. In the UK, the deputy governor of the Bank of England called Britain to “bring these activities and entities within regulation.” After FTX's failure, FINRA also started collecting data on crypto marketing practices — which could lead to new policies.
This signifies a new era of regulation for the crypto industry. While this is generally seen as a positive development, it does raise some concerns for privacy coins. These coins are designed to provide a high degree of anonymity and privacy for their users, and new regulations could potentially jeopardize that.
Regulatory Impact on Privacy Coins
The use of privacy coins is a controversial topic in the world of cryptocurrency. Some think they should be banned, while others believe regulators should allow their use. Proponents argue that restrictions on privacy tokens and related technologies would be legally misguided and bad for society.
Observers like the policy group CoinCenter and Electronic Frontier Foundation (EFF) regard anonymous digital transactions as crucial for preserving civil liberties in the 21st century.
There has always been a demand for privacy coins, as some people prefer to keep their online identities secret and do not want to make their cryptocurrency transactions visible for everyone to see. Privacy coin advocates say that they can be used for entirely legitimate purposes by anyone who wants to avoid potential surveillance from outside parties, giving the user the power to control what information he or she chooses to share with companies and organizations.
Coins enabling anonymity are legal today in jurisdictions where cryptocurrencies are more widely accepted, but some exchanges are cautious about potential fights with regulators down the road.
Can Privacy Coins be Stopped?
Regulators have always paid special attention to privacy coins. In the US, while they remain legal, the Secret Service has recommended that Congress regulate privacy-enhanced crypto.
On Aug. 8, 2022, the US Treasury Department barred customers in the US from using Tornado Cash, a decentralized mixer protocol that enables private transactions on Ethereum, sparking questions around privacy protocols and privacy coins generally. Amidst this heat from regulators in the UK and the US against using coin-mixing tools, Coinjoin, a popular crypto-mixing tool, announced they would be blocking illicit transactions.
Additionally, the Internal Revenue Service (IRS) announced in Sept. 2020 that it was offering up to $625,000 in rewards to anyone who can hack into Monero — suggesting that the agency believes the coin could be used to hide taxable income.
Meanwhile, cyber security company Cipher Trace has filed not one, but two patents on a technology they say can monitor transactions across the Monero network. However, the firm points out that, transaction-tracking tools or not, privacy coins are increasingly being scrutinized by crypto exchanges.
Japan was one of the first countries to ban privacy coins, after which several registered crypto exchanges delisted them from their platform. Similarly, South Korea has not only banned privacy coins but has gone one step further by outlawing any form of private transactions on Korean crypto exchanges.
Tightening the “know your customer” laws imposed by anti-money laundering regulators may make life difficult for users of privacy coins. These include the FATF Travel Rule and the AMLD-5 directive set by the European Union. It may become increasingly difficult for users of privacy coins to use without being flagged by authorities.
To operate with a license obtained from the government or a government-affiliated body, most crypto exchanges have discouraged any anonymous transactions. Even in countries where there is no law banning privacy coins, there is typically a ban on private transactions over a certain threshold.
Despite all this, it seems unlikely that privacy coins will be stopped anytime soon. Their popularity is only increasing as more and more people become concerned about their online privacy. But while it is likely that there will be many people who continue to use them even if privacy coins are eventually outlawed, regulators can make it difficult for these coins to be traded. We have already seen many crypto exchanges delisting privacy coins.
Coins Not Available for Use
There have been several notable instances of crypto exchanges delisting privacy coins in the past. In most cases, the exchanges cited concerns about the coins' compliance with anti-money laundering (AML) and countering-the-financing-of-terrorism (CFT) regulations. In some cases, the exchanges also cited the lack of regulatory clarity around privacy coins as a reason for delisting them.
One notable instance of a crypto exchange delisting a privacy coin was when Bittrex removed Monero, Zcash, and Dash from its offerings in January 2021. This shift resulted from the careful dance between global financial regulators and crypto exchanges. Another notable instance was when the self-custody exchange ShapeShift delisted the three coins.
Before that, in 2019, the South Korean subsidiary of OKEx delisted five privacy coins, including Monero, Dash, and ZEC, citing AML rules from the G20's Financial Action Task Force — specifically, that an exchange must have the addresses for both sender and receiver of the cryptocurrency transaction, something that privacy coins lack.
Another instance was Kraken delisting Monero in the UK in November 2021, following guidance from the United Kingdom's financial markets regulator.
Just a few months back, in Sept. 2022, HTX said it would delist seven privacy coins — Dash (DASH), Decred (DCR), Firo (FIRO), Monero (XMR), Verge (XVG), Zcash (ZEC), and Horizen (ZEN) — in light of increased regulatory scrutiny.
Even though privacy coins are still available on more popular exchanges, like Coinbase and Binance, their recent delistings highlight the ongoing tension between exchanges and privacy coins.
Financial regulators usually put a lot of pressure on centralized exchanges to keep an eye on their users. But privacy coins can make it more difficult to monitor where they're being sent, which goes against what the regulators want. This can lead to increased regulation of these coins and enhanced scrutiny of the exchanges that list them.
Final Word: The Right to Financial Privacy
Privacy is a top concern for many in the cryptocurrency community, especially when it comes to sensitive information like financial transactions. That's why privacy coins are important for preserving and securing users' interests. They ensure that sensitive user data is not accessible to just anybody and that transactions are conducted privately.
Not to mention, individuals in a free society should be able to enjoy financial privacy. This includes keeping their financial information private and away from prying eyes.
But regulators continue to target privacy coins despite the fact that only a very small percentage of cryptocurrency transactions have been associated with criminal activity.
A complete ban on privacy coins could cause a threat to user privacy and stifle innovation of the underlying technology. And only time will tell whether privacy coins will be able to survive in this new regulatory environment.