The emergence of Bitcoin has proved to be an important landmark because it has demonstrated that a peer-to-peer spendable digital currency is possible. However, despite the tremendous successes that Bitcoin has racked up in its nine years of existence, there is one area that it has proved weak in: privacy.
This apparent weakness of Bitcoin has encouraged the development of other cryptocurrencies that have much stronger privacy features, ensuring that users and their transactional information can truly remain completely private and anonymous.
Bitcoin Pseudonymity and Fungibility
It is often thought that Bitcoin is a private and untraceable cryptocurrency; however, this is a common misconception. User identity on the blockchain is somewhat disguised, as usernames are replaced with public addresses. However, this protection is more pseudonymous than it is private.
If one can link a Bitcoin address to an individual, then, it is possible to track the flow of funds moving in and out of that address and to effectively determine that individual’s transactional habits. One could also be able to identify other parties that may be transacting with that same address.
This weak privacy feature of Bitcoin also results in issues relating to fungibility. Fungibility describes a good or commodity whose individual units are interchangeable. For example, the U.S. dollar is fungible because one U.S. dollar is the same as another corresponding U.S. dollar.
This ease of interchangeability is one that may evade Bitcoin given its weak privacy features. For example, if it becomes known that a Bitcoin public address engages in illegal activity, then, the Bitcoins contained in that address might become “tainted” from the perspective of other users on the network.
Merchants and other individuals might not accept those Bitcoins because they may not want to fund the illegal activities that the address is engaged in. In this instance, the Bitcoins contained in this address are not fungible since they become harder to interchange with another equivalent unit of Bitcoin.
Strong privacy features resolve this problem because, if an individual cannot identify the origins and flow of funds on the blockchain, then, they have no knowledge of its history. In this case, merchants and other individuals are more likely to accept it in their transactional activities.
There are numerous projects that are developing privacy coins, with the most notable ones being Monero, Zcash, and Dash.
- Monero. It is a specially privacy-focused cryptocurrency that was launched in 2014. Monero brings greater privacy to users transacting on its blockchain by employing three distinct technologies:
- Ring Signatures. Monero ring signatures protect user privacy on the input side of a transaction. It does this by merging a group of possible signers to produce a distinctive digital signature that is capable of authorizing a transaction. This makes it incredibly difficult for a third party to identify who exactly authorized a transaction on the blockchain.
- Ring Confidential Transactions (RingCT). Monero RingCT functions by hiding the value of funds that are being transacted on the blockchain. It does this by employing a cryptographic proof that shows that the input of a transaction is equal to its output, all without the need to reveal the actual value of the transaction.
- Stealth Addresses. This feature provides added privacy to user addresses on the Monero blockchain. Stealth addresses require a sender to create one-time addresses for every transaction on the recipient’s behalf. This, then, makes it difficult for a third party to link any transaction to the recipient’s actual address.
- Zcash and zk-SNARKs. It is another privacy-orientated digital currency that was founded by Zooko Wilcox. Zcash’s main privacy feature is its novel zero-knowledge cryptography known as zk-SNARKs, which stands for “Zero-Knowledge Succinct Non-Interactive Argument of Knowledge.” zk-SNARKs function by encrypting transactional data that is stored on the blockchain. It is, then, able to verify that this transactional data is accurate without having to reveal any data. Zcash’s privacy feature is optional, which gives users the option to opt in or out of it.
- Dash. It is another digital currency that is geared toward providing privacy functionality to transacting users on their blockchain. Dash does this by the use of its PrivateSend function, which is a decentralized coin-mixing feature on the network. The PrivateSend function works by mixing a user’s funds with others on the network, which makes it difficult for a third party to determine where the funds actually came from.
Although Bitcoin has proved to be the most dominant cryptocurrency over the last few years, it has not been able to address the needs of all of its users. And, in an era in which privacy is becoming a more important issue in the community, it appears that some individuals are favoring cryptocurrencies such as Monero, Zcash, and Dash, which are proven to be more effective at protecting user privacy.
It is also likely that we will begin to see non-privacy focused projects add privacy features to their cryptocurrencies to strengthen user anonymity. Projects such as Litecoin and Ethereum have all expressed the desire to add privacy features to their blockchains, along with IOTA and their tangle architecture.