Privacy Coins: Debunking Myths about Illegal Usage of Cryptocurrencies
The goal of the Miami University Blockchain Club is to help facilitate the understanding of cryptocurrency and Blockchain technology within the Miami University community. While attempting to spread the word about Bitcoin at Miami, I have noticed many students believe that cryptocurrency is used exclusively for buying illegal goods on the internet. A stigma has been attached to digital currency that it’s “anonymous” and used for nefarious purposes such as money laundering, drug purchasing, and terrorist funding. In this blog I am going to give a brief introduction to Bitcoin, the world’s first decentralized digital currency, and explain why cryptocurrency has been unfortunately linked to illegal activity.
The innovation and financial inclusion brought about by Bitcoin has greatly outweighed the illegal usage and bad players in the ecosystem. Due to Bitcoin’s open nature and traceability, several new cryptocurrencies have been created in order to emphasize anonymity. These coins promote privacy, and allow users to transact without being traced or linked to other transactions. My goal in this article is to debunk the myth that virtual currency is used only by criminals, and outline why new privacy-focused cryptocurrencies, namely Zcash, Monero, and Dash, are useful for lawful members of society.
On October 31, 2008, an anonymous researcher (or researchers) going by the pseudonym of Satoshi Nakamoto, emailed a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” to a cypherpunk mailing list. The paper outlines Bitcoin, a digital payment system, which allows two parties to exchange digital “cash” without relying on a trusted intermediary. Before Bitcoin was introduced in 2008, every decentralized virtual currency attempt had failed at solving the double-spend problem, the classic computer science problem associated with value transfer. Double-spending occurs when someone successfully spends a certain amount of money more than once. For example, someone may send digital tokens to two parties at the same time. In standard electronic payment systems such as Paypal or Venmo, the sender and receiver trust the authoritative body to verify transactions, thereby eliminating double-spending and fraudulent activity.
Bitcoin is the world’s first peer-to-peer digital currency that does not rely on a third party to verify transactions. Instead, it relies on the blockchain, a ledger which contains every Bitcoin transaction ever processed. This allows every user the ability to verify the validity of each transaction on the Bitcoin network. Decentralized participants known as “miners” group transactions into an individual block every 10 minutes (hence the blockchain). They then secure the network by using specialized hardware to compete to solve a complex math puzzle, known as a proof of work problem. Whichever miner successfully solves the PoW problem gains the authority to broadcast the block to the entire network and add it to the blockchain. Each node in the network then updates the state of their blockchain with the new block linked to the previous one, creating an immutable and authoritative record of transactions.
The miner who solves the problem receives the current block’s reward: transaction fees and newly minted bitcoins. Because there’s massive amounts of computing power needed to mine a block, it’s economically beneficial for miners to approve valid transactions and mine honestly. According to Bitcoin’s programmability, bitcoins are created at a predictable and decreasing rate (currently 12.5 BTC/10 mins) with a max supply of 21 million, so that the last minting of coins will occur in the year 2140. This allows for a steady supply, ensuring the currency will never suffer from hyper-inflation.
Launched in February, 2011, The Silk Road was the world’s first modern dark web marketplace. The platform leveraged Tor Browser, a worldwide network consisting of thousands of relays to conceal users’ identities and locations. The Silk Road was best known as an exchange for buying and selling anything imaginable such as drugs, weapons, fake IDs, and more. It was launched by ‘Dread Pirate Roberts’, the pseudonym used by Ross Ulbricht. Ulbricht was a mastermind libertarian idealist who despised government regulation and promoted free-market capitalism. Eventually, he was arrested in October of 2013 and sentenced to life in prison for running the site. His sentencing was a message to all darknet operators that law enforcement would not be lenient in regards to punishment for these crimes. So what does this have to do with Bitcoin?
Before the Silk Road was launched, there was little utility value for Bitcoin. Very few merchants accepted the digital currency, it wasn’t used for remittances (arguably its best value proposition), and there was no plausible way to spend bitcoins. The Silk Road changed that, as it was the first legitimate use case for the currency. This new attention brought Bitcoin directly into the mainstream. It allowed buyers anywhere in the world to purchase goods with bitcoins over the Internet quickly, “anonymously”, and with virtually no fees attached. It seemed to be a match made in heaven. To illustrate the importance the Silk Road had on the Bitcoin ecosystem, we can simply look at its price chart over the Silk Road’s lifespan:
BTC price chart from the founding of Silk Road to its demise
The price of Bitcoin at the beginning of the Silk Road days hovered around $1. At the time Ross Ulbricht was arrested and the website shut down, the price was at about $133. The value of Bitcoin seemed to rely on its trusty dark web partner, however, instead of Bitcoin falling through the cracks and losing legitimacy, the currency flourished after the Silk Road’s closure.
The Silk Road website’s demise and subsequent trial proved that Bitcoin’s intended use case was not for avoiding law enforcement. Many expert cryptocurrency advocates believe that cash is actually king to Bitcoin for illegal usage. Because of the transparent nature of the Blockchain, any transactions coming in and out of any Bitcoin address can be traced back to that exact address. The reason people believe Bitcoin is anonymous is because each individual address is just a string of characters (1A1zP1eP5QGefi2DMPTfTL5SLmv7DivfNa).
This means bitcoin transactions are actually ‘pseudonymous’. In most cases there is no way to attach personal information to a certain Bitcoin address. However, if a user was to link their address to a centralized exchange, public donation address, transact in person, or simply pay a merchant while using personal information, their identity would be exposed. These reasons show why Bitcoin is actually a poor choice for conducting illicit activity.
Privacy has been neglected in our financial system for far too long. Banks, merchants, lenders and other central authorities require customers to provide SSNs, addresses, names and more. Financial institutions and governments tend to enforce the belief that anonymity = illegality. However, as cryptocoinsnews argues, “Imagine if everyone could type in your name and see every website you’ve ever visited, all your bank transactions and any private conversations you’ve had. I would bet you’ve said things about people that would hurt their feelings, visited websites your significant other might not approve of, as well as given up so much information that hackers/stalkers/enemies will be able to use against you”. The same privacy principle can be applied to transfer and store of value, and there are several instances when good samaritans could benefit from anonymity coins.
Why the World Needs Privacy Coins
- Illegal Origins: The transparent nature of Bitcoin poses risks for buyers of BTC who are unaware of how the seller received those bitcoins. For example, if a law-abiding user of Bitcoin unknowingly buys BTC on LocalBitcoins from a suspected drug trafficker, they could be at risk of being traced by law enforcement and suspected of partaking in illegal activity.
- Fungibility: Also, an essential component of currency is fungibility. If I have $1 USD and you have $1 USD, they are equal to each other. On the contrary, if a Bitcoin user buys from a suspected criminal, exchanges may not accept the currency and it could be deemed worthless. Privacy coins allow for 100% fungibility as all transactions are hidden and traceability is impossible.
- Wealthy Hodlers: Imagine a Bitcoin user has $100 million dollars of Bitcoin tied to one address. If that bitcoin address is ever tied to an individual, anyone in the world can view its balance and prey on that person for their wealth. If I was to travel to Zimbabwe tomorrow to arb BTC +100% ;) on the streets, the buyer would know how many bitcoins I have in the particular address I transacted with, and it could potentially put a target on my back. Privacy coins eliminate that problem by hiding each address’s token value and transaction history.
- Private Business: If you are a business who receives payment from suppliers, you would not want pricing information to be available to the public or other businesses. Different vendors could use that public data to raise prices or adjust knowing how price sensitive you are willing to be in the future. Companies often have information which needs to be protected, and coins like Monero and Dash enable privacy for these businesses. This problem can also be resolved with a permissioned private or consortium blockchain, however, decentralized consensus is completely lost when private blockchains are deployed.
All of these are valid reasons why anonymity coins are needed by noncriminals. I have decided to outline some key privacy coins below, and how each establishes anonymity for participants in its own respective network:
Zcash is a cryptocurrency that was founded in October, 2016 out of the Zerocoin project. The project received so much hype that on the day of launch the price hit $2 million USD per coin. It has since settled down to around $266 per token (talk about getting in at a bad time lol).
Zcash uses zk-SNARKs, a zero-knowledge proof construction that provides anonymity to users. A zero-knowledge proof allows one party to prove to a different party that a statement is valid, without revealing any information about the statement itself. In Zcash’s example, Zcash payments are published on the blockchain as valid, however the amount, recipient, and sender information remain concealed. The privacy feature is actually optional, in case participants want to be open and transparent for auditability reasons.
Monero is a cryptocurrency which launched in April of 2014 and emphasizes privacy, decentralization and anonymity. Monero’s first privacy component is the stealth address. This feature allows recipients to receive payments to a single address where they cannot be linked back to their own published address or the address of any other transaction. It does this by forcing senders to create a random, one-time address intended for the recipient. Recipients’ payments cannot be linked together on the Blockchain because each random, one-time address is broadcasted to the network.
Monero’s second key feature is a Ring Confidential Transaction (RingCT). RingCT is an improved feature of the original ‘ring signatures’ Monero deployed. RingCTs have the ability to hide transaction amounts, as well as origins and destinations of transactions themselves. The Ring CT protocol is similar to Zcash in that transaction values are hidden, however, proof of work mining is possible with Ring CT. These two features allow Monero to be completely untraceable, and, as a result, it’s a great currency for keeping anonymity.
Dash is another private peer-to-peer cryptocurrency that has an optional feature of anonymity. It was originally released as XCoin, then changed its name to Darkcoin, and finally rebranded to “Dash”. They use a modified version of CoinJoin, an original anonymization method for Bitcoin which helps find other users to make joint payments.
Dash uses its PrivateSend feature (formerly known as DarkSend) to create anonymous transactions on the blockchain. PrivateSend allows senders’ wallets to break down transaction inputs into standard denominations (1 Dash, 0.1 Dash, etc) that are uniform with others on the network. The wallet then sends a mix request and tx fee to a randomly selected masternode to jumble the denominations with other senders’ coins. Masternodes then instruct all user’s wallets to pay the now-transformed input back to themselves (change addresses). Each PrivateSend jumbling process (round) that occurs makes it exponentially more difficult to track where the funds originated.
Anonymity is scarce in today’s digital world. Members of society have been convinced by centralized financial institutions that revealing private information is necessary in order to transact over the Internet. As a member of the crypto community, I feel it is necessary to address the negative consequences of exposing sensitive information. Just like people don’t want others to see their bank account or spending habits, they probably don’t want others seeing their crypto transactions either.
We should start to see a paradigm shift towards privacy coins like Dash, Monero and Zcash, that allow for secure and private transactions across the globe. Will there be bad eggs who use private currencies for illegal activity? Absolutely. However, the truth is that private virtual currencies do more good for the world than bad. As a result, anonymity coins should be adopted into trade finance, everyday spending, remittances, and everything else we currently use digital money for. From a development standpoint, I hope we’re only at the tip of the iceberg of private cryptos, and that they will continue to flourish and disrupt the world’s economy as we know it.
Then again, I’m a full-fledged crypto anarchist, so what do I know?