What are Privacy Coins?

This is part 4 of an introductory series, written to explain some of the high level concepts within the world of cryptoassets and blockchain technology.
Part 1/Part 2/ Part 3

Privacy coins, like Zcash and Monero, are cryptocurrencies designed to offer complete privacy and untraceability when transacting. Their creators are passionate believers that financial privacy is a human right and an integral part of a free society. They are also wary of a future in which all transactions are digital and everyone’s private financial information can easily be exposed.

Zcash and Monero each use techniques that make them private in ways that Bitcoin and other cryptocurrencies are not. Where every Bitcoin transaction leaves a digital trace that is publicly viewable, Zcash and Monero work more like physical cash — transactions occur leaving barely any record that can be traced back to the sender or receiver. Zcash and Monero are early stage technologies whose ultimate place in society is uncertain.

However, in an age where we increasingly leave our sensitive, personal information online and out in the open, there is a great deal of interest in more private transactions. There is arguably a strong case for the need to keep financial information private, for both businesses and individuals as high profile data hacks are on the rise. Furthermore, the technology that underlies
privacy coins is being explored to solve pressing societal problems related to data security and beyond.

Bitcoin — not fully private

Before you understand what makes Zcash and Monero private, it helps to understand why Bitcoin and most cryptocurrencies are not fully private — by design, all transactions take place unencrypted and out in the open for all to see.

Bitcoin works by recording every transaction to the Bitcoin blockchain — an open public ledger that keeps track of how much bitcoin every user owns. When a new transaction occurs, the system verifies that the sender has enough bitcoin before processing the transaction and updating the balances of the sender and receiver on the blockchain (we are simplifying the
details here a bit).

For a transaction where Rachel sends Sean 1 bitcoin, the following is publicly broadcasted:

Sender Address: 1Mz7153HMuxXTuR2R1t78mGSdzaAtNbBWX

Amount: 1 Bitcoin

Receiver Address: 3PtJRj5xKUKJ21TshP5u2G6dQMPNz2yUSc

Those long strings of digits are the Bitcoin equivalent of an email address, called a public address. Just like you can create the email address alias123@gmail.com that is not tied to your name, Bitcoin public addresses don’t contain personally identifying information. In that sense, Rachel and Sean’s transaction is anonymous.

However, for each public address, someone can look up every transaction its ever made along with its bitcoin balance. If someone were to figure out that the sender’s address belonged to Rachel, they would be able to see a history of every transaction that Rachel has ever made and how much bitcoin she owns. If Sean knew that the above bitcoin came from Rachel, he is now privy to all that information. In that sense, Bitcoin is only semi-private and advanced data analytics tools are making it easier for analysts to make inferences about Bitcoin transactions.

A more private blockchain

Cryptocurrencies operate by replacing the main function of traditional financial intermediaries with a blockchain. Where banks keep track of how much money everyone has on a central database, cryptocurrencies keep track of how much money everyone has on a publicly viewable blockchain.

As demonstrated with Bitcoin, the result is a semi-anonymous record that
outsiders can analyze and draw conclusions from. Zcash and Monero also keep track of transactions on blockchains; the key difference however,
is that Zcash and Monero use techniques that prevent anyone attempting to analyze their blockchains from making any sense out of what they’re looking at.

Accomplishing this is no small feat and involves complex methods of cryptography — a science used to prevent messages from being understood by third parties. As the name suggests, all cryptocurrencies use cryptography to function — Zcash and Monero just use more advanced methods that render their transaction histories indecipherable.

Techniques called ring signatures, ring confidential transactions, stealth addresses (Monero)and zero-knowledge proofs (Zcash), enable all of the benefits of public blockchains like Bitcoin without the downsides of leaving behind digital clues that can be analyzed by third parties. The result is the ability to transact with complete privacy, inscrutable to the outside world.

The case for privacy

The importance of preserving financial privacy is a continuously evolving, complicated debate. On one hand, the right to privacy can be abused to hide nefarious and dangerous behavior. On the other hand, a society in which we have zero expectation of privacy is one in which we are arguably not truly free.

The creators of Monero and Zcash argue that privacy is an essential part
of a free society and that their technologies can help preserve that freedom.
The Zcash and Monero creators point out that we’re moving towards a world in which almost all transactions are digital, and most people don’t think about how much data their day to day financial activities leave behind. Whether we’re trusting third party credit card networks or payment services to safeguard our financial activity or we’re using semi-private cryptocurrencies
like Bitcoin, we run the risk of scrutiny from the outside.

If our expectation of financial privacy slowly erodes in a purely digital economy, their concern is that we may one day find ourselves questioning our everyday purchasing decisions, which should not occur in a truly free society. Supporters of privacy coins argue that there is power in giving people complete control over who sees their data. With high profile hacks of sensitive financial data from institutions like Equifax (2017) and JP Morgan Chase (2014) occuring in growing in frequency, they cite the benefits of transactions disconnected from personally identifiable information completely.

They also reference numerous historical examples in which governments have unfairly confiscated wealth from their own citizens. In extreme cases, private and unseizable wealth, they point out, can be a powerful thing.

Mainstream applications of privacy tech

The same attributes that make this technology powerful also make its future place in mainstream society uncertain. In modern societies, sensible regulation is an integral part of a well functioning economy. To remain regulatory compliant, the majority of businesses are required to have an idea of who they are doing business with. Purely anonymous currencies like Monero and Zcash make this very difficult so it remains unclear where they fit in.

Despite this uncertainty, there is tremendous excitement surrounding the technology that privacy currencies run on — particularly with Zcash. MIT’s Technology Review named Zcash’s application of zero knowledge proofs as one of the biggest breakthrough technologies of 2018 — mainly due to its potential application in solving many existing issues related to online financial
privacy.

The excitement is such that JP Morgan Chase is trialing Zcash technology. They see the technology’s potential to allow their customers to transact securely without the threat of their personal information being exposed by hackers. They are also exploring methods for allowing the appropriate regulators, “view only” access to transactions to remain compliant. Their interest in privacy preserving technology speaks to the fact that privacy is important to not only individuals, but businesses as well.

Many see the potential to apply Zcash’s privacy preserving technology beyond finance. The same technology may one day power the online elections of the future. The creation of online voting systems that let people prove they’re eligible to vote without revealing their identity or expose how they voted becomes possible.

The future of privacy

Zcash and Monero have both been praised for their cutting edge technology that has established its ability to keep transactions private. There is certainly a societal case for preserving privacy for both businesses and individuals, especially within a global economy that’s increasingly digital. What remains unclear is the path that these technologies will take towards reaching meaningful adoption.