Privacy Coins: What Are They & How Do They Work?

One of the hype points of blockchain transactions is that they are anonymous and untraceable (at least, this was one of the selling points of bitcoin when I joined the market several years ago). It may sound rather confusing as to why a group of coins will then be dubbed privacy coins, when cryptocurrencies have been touted for their anonymity. It is important to note that privacy coins are an evolution of legacy projects like Bitcoin and Ethereum; they take privacy to a whole new level.

Regular cryptocurrency transactions are anonymous in the sense that the owner of an address is unknown. However, every transaction gets broadcasted publicly on a public ledger, and can be seen by everyone. Why this may not seem like a problem, it means every transaction can be seen and audited, and if a person’s real identity is linked to his online wallet, then his anonymity is compromised.

Privacy coins are not so different from cryptos like Bitcoin and Ethereum, in terms of functionality. Transactions are also broadcasted on a public ledger. However, in order to hide the identity of wallet owners, these wallets and projects adopt a host of options to obscure the link between the sender and receiver, which prevents tracking of the activity of wallet addresses. Some top privacy coins include Monero, ZCash, Dash, and PIVX, amongst many others.

Why Privacy Coins?

Considering the level of anonymity most public ledgers already provide, why should anybody be bothered about increased privacy? For a start, governments are coming in with regulations and if you’ve been in the space long enough, then you’d agree that KYC and AML processes are now part of the signup procedures in most exchanges. Put differently, anybody with access to this centralized data (whether a staff of an exchange or a hacker), can link your digital transactions to your offline personality. This can be particularly dangerous considering the fact that there have been kidnap cases with criminals asking for bitcoin payments.

Governments and the powers-that-be can also easily follow the transaction trail and get your real identity, because at some point, we all cash out.

How Privacy Coins Work

Privacy coins conceal the identities of a sender and recipient of a transaction. There are three popular privacy algorithms, namely; RingCT, Coinjoin, and zk-Snarks.

RingCT which is used by Monero involves obscuring the amount moving from one account to another through ring confidential transactions (RingCT). When paired with stealth addresses, transactions can become literally invincible.

Coinjoin was developed by Gregory Maxwell and employs a ‘safety in numbers’ approach to protect the privacy of users. In this protocol, two senders dispatch a transaction of identical amounts, which is then converted to a joint payment. Linking the input and output of such a transaction is practically impossible. Other similar protocols being employed by other crypto projects include Private Send by DASH, and Coin Shuffle by Bitcoin Cash.

Zk-Snarks which stands for “Zero-Knowledge Succinct Non-Interactive Argument of Knowledge” is a protocol used by ZCash. In this case, miners verify transactions without knowing who sent or received the coins. Ethereum is currently testing zk-Snarks.