On-Chain Privacy: By Default, For All, On Cosmos
Lack of on-chain privacy is a bug, not a feature, limiting the attractiveness of DeFi and GameFi on the blockchain.
Secret Network is the live, here-and-now solution.
Governments generally accuse blockchains of being too secretive. They see ransomware demands denominated in Bitcoin, dark web payments on the latest Silk Road incarnations beyond the reach of authorities, and tales of tax evasion as evidence that we need more on-chain transparency and traceability.
Biden’s administration has claimed in that
Cryptocurrency already poses a significant detection problem by facilitating illegal activity broadly including tax evasion.
While crypto is certainly still used to fund some illicit activity, such use cases are falling in importance as the markets explode in size. The percentage of total crypto assets used for crime is at an all-time low.
This is because blockchains are not anonymous, but pseudonymous. All transactions are public, and there are an increasing number of services that follow wallets, in many cases being able to trace a lifetime’s worth of transactions
As a result, criminals and tax evaders and, lately, “rug pullers” stealing funds from crypto protocols, are regularly tracked, caught and prosecuted. Funds from some of the most high-profile attacks were at least partially recovered. All of the money from crypto’s largest hack, on Poly Network, was returned.
This is because the funds are traceable. And once investigators can match public keys to real identities, the jig is up. This service is offered by companies like Chainalysis to authorities. The growing, highly-engaged cryptocurrency community is also constantly enhancing the power of cryptocurrency’s transparency. In their report they reveal that on-chain privacy is non-existent.
Whereas criminally obtained fiat currency can be moved through shady bank accounts, with authorities relying on subpoenas and cooperation of financial institutions to trace its path, anyone in the world can view cryptocurrency transactions made on public blockchains.
Transparency and pseudonymity might be useful for tracing criminal activity, but it’s a bug when it comes to performing financial transactions.
There is a reason we have financial privacy laws. Banks and other financial companies are not permitted to reveal client transactions to just anybody. And much of our data, in general, is mandated by authorities to be private by default.
Privacy is not about avoiding the taxman’s eye, or committing a crime. It’s a necessity for transacting in the public domain. If I pay for my Starbucks on-chain, they will now be able to follow all of the transactions I have ever done, and trace all those I will do in the future.
In order to provide comfort to those engaged in financial transactions, blockchains will require privacy features of some kind.
While we are convinced that privacy will become a critical feature in the evolution of blockchain technology in general, the best solution for most DeFi and other transactional use cases is a layer 1 smart contract platform blockchain with programmable privacy. Secret Network not only uses a trusted execution environment (TEE), effectively a back box, to achieve smart contract privacy, bridging to and from other Cosmos IBC chains such as Terra or Juno, is trustless, cheap and seamless.
Secret Nodes, which are a decentralized network of computers, afford the computational resources to process encrypted data but are not capable of viewing the data they themselves compute. For use cases where selective disclosure is required, however, Secret allows a user to reveal transaction histories to selected counterparties, such as the tax authorities. Selective disclosure of the encrypted information is allowed through a set of “viewing keys.” The end user has complete sovereignty over the keys.
Transaction privacy is essential
The pseudonymous and transparent nature of blockchains hinders many legitimate use cases. That anyone can publicly view what asset you hold and how you’re deploying funds, even if pseudonymous, makes blockchains unsuitable for mass adoption in financial transactions.
There are numerous issues that arise from having all of your on-chain activity on public display, primarily from the ability to track wallets and eventually link addresses to identities. Several key consequences can arise from pseudonymity:
- Other traders can follow larger wallets and mirror their transactions
- In many blockchain, the mempool that is used to build a block is visible to miners before the block is finalized. This allows attackers to insert their own, more-profitable, transactions to steal “miner extractible value” (MEV) from other users.
- It can turn into identity: Large users, once “doxxed”, are vulnerable to the “$5 wrench attack”, where they are forced to give up their private keys under threat of violence. Identify wealthy individuals for wrench attacks or other scams (find the twitter about the one guy who had serious psyops because they could see his wallet in Aave)
- Scammers can airdrop unsolicited obscene photos into a corporate NFT wallet, causing branding nightmares and potential unintended illegality.
So privacy is not just for criminals and tax evaders. It is essential for a free society, where (legal) economic decisions can be made freely and without consequence. This is as true now as it was in 1993.
So what has crypto come up with to solve the privacy problem?
The privacy revolution
As it stands today, almost all privacy solutions share one major problem — a lack of composability with DeFi, NFTs and gaming. That is, the existing landscape of crypto innovation and privacy are mostly mutually exclusive.
The existing privacy landscape can be broken out into 5 segments:
- Privacy Coins
Privacy coins such as Monero, Zcash, and Pirate Chain allow for storage and transactions of wealth privately. One can send remittance to wallet holders of these currencies similar to BTC with the added benefit of privacy. Privacy is achieved using ring signatures (Monero) or zero knowledge (Zcash, Pirate) technology. However, the trade-off is they’re isolated and their standalone nature renders them non-composable with prominent DeFi ecosystems. While one can bridge wrapped versions of these coins in smart contract enabled ecosystems, the current state of bridging itself is a risky endeavor that compromises the elements of security and decentralization in most bridging solutions.
Given that privacy coins are highly efficient as a haven for storing wealth, they might be considered more sound than BTC.
2. On-chain Mixers
So-called Mixer Dapps achieve a limited form of privacy on public blockchains by muddling up funds via a series of addresses and ultimately obfuscating the original source address, rendering it difficult to track. When a user deposits funds in Tornado Cash, the protocol generates a random key and deposits ERC-20 tokens into smart contracts. To make withdrawals in the future, the user will need proof of having the valid key. The deposited funds can be withdrawn to a variety of addresses. By breaking the link between source and destination addresses, Tornado Cash enhances privacy of on-chain transactions.
However, sophisticated software like Chainalysis, which covers 90% of all volume in blockchain with the primary goal of blockchain surveillance, will likely win out the battle with greater tech that enhances surveillance capabilities in the future, making mixers obsolete.
Additionally, mixer efficacy hinges on the size of the pool of assets a user wants to obscure. Deposit liquidity size and level of obfuscation are directly correlated, forcing users to transact in a limited pool of assets with higher liquidity thresholds to achieve anonymity. Upon withdrawal to a new address, user funds and transactions are rendered pseudonymous anew. And tracking can begin again.
3. Standalone Dapps
Evolving from traditional layer 1 UTXO based privacy protocols are standalone blockchains that bestow privacy and DeFi features. It’s exciting to see protocols like Penumbra, built on the Cosmos SDK, that are conducive to privacy-centric applications (e.g., its interchain DEX). Haven is another exciting protocol that enables minting of private derivative assets on its native chain, and with the forthcoming Thorchain integration it’ll allow for native asset cross-swaps, making it more composable with DeFi.
Offshift is another protocol that allows the minting of private synthetics on Layer 1 Ethereum using zk-bulletproofs, the most secure form of privacy technology. However, these standalone applications do not permit developers to build complex decentralized and permissionless applications that also protect data privacy (e.g., NFT marketplaces, social media apps, or messaging dapps) given they do not have an integration of a smart contract execution layer.
4. Layer 2 PriFi
Layer 2s, on top of ETH, allow users to conduct transactions anonymously using ZK-rollups. One notable platform that is live and offers this solution is Aztec Protocol, who were the originators of an on-chain confidential token standard in EIP-1724. Unfortunately, there are centralized elements to most layer 2 solutions. To be specific, protocols such as Aztec lack the level of decentralization relative to a protocol that would provide privacy as a layer 1 smart contract solution with a greater number of validator nodes.
Secret: The layer 1 private smart contract protocol
A multitude of layer 1 privacy smart contract platforms are on their way. While forthcoming protocols such as Mina and Dusk check the boxes in terms of privacy, decentralized SOV, and a smart contract execution layer, they are not as well positioned on the multi-chain composability front (IBC connectivity, more later).
Oasis (ROSE) achieves privacy in the same way as Secret, but [what]does not have the first mover advantage nor the IBC connectivity for interoperability with other highly liquid and sovereign chains.
Given the aforementioned private smart contract L1s are not live yet, they will face a plethora of challenges/risks that investors should consider, including achieving critical mass in terms of network effect and attracting developers to build a compelling app ecosystem. Being a first mover may have tremendous advantages.
Secret Network was the first protocol equipped with programmable privacy features to go live in September 2020, and is poised to be a market leader in the much needed area of private computations. Secret has already solved, or is in the process of solving, key challenges such as UX, security, cost and complexity of inter-chain bridging.
Secret leads on many fronts, including DeFi and NFTs, and is equal or better in providing a platform for private payments. This has translated into a growing user base before competitors even get started.
DeFi — The growth of decentralized finance applications on Turing complete smart contract platforms has been extremely impressive. However, as we noted above, not only is privacy a condition precedent for fair and free financial transactions, transparent mempools open market transactions up to exploitation by MEV bots. MEV extracted from users has been steadily growing on public blockchains, totalling over half a billion to date.
The challenges for DeFi participants experienced on public chains like Ethereum are virtually removed on Secret Network. Besides privacy by default for every transaction, Secret uses encrypted “secret” smart contracts that prevent secret nodes (validators) from viewing transactions, so no front-running is possible.
Payments — Private coins such as Monero or Zcash introduce obvious drawbacks such as price volatility and unwelcome attention from authorities. Privacy coins typically are usually targeted first by regulators, and have often been delisted due to coercion by regulators. Private stablecoins that can be private to most but revealed to authorities have yet to exist outside of Secret Network.
NFTs — Public chains link NFT ownership to a wallet address that can be doxxed, while content creators on public chains have no way of guarding aspects of their material and production.
Given that Secret is private by default, the network permits NFTs with programmable privacy: Private metadata, private ownership, and access control, described below.
The future of Secret: More Dapps and better UX
As a first mover, Secret Network is further ahead than other private layer 1 blockchains, with multiple DeFi and NFT dapps either live or in the pipeline such as Secret Swap, Sienna Swap, and Shade Protocol (algo stable). With the recent launch of stashh.io (NFT marketplace), it’s expected that retail capital inflow will come for the NFTs and stay for the DeFi.
While other solutions will need to solve the cross-chain composability issues, the IBC integration allows it to tap into the growing liquidity of protocols like Osmosis and Terra, converting assets like LUNA and UST into sLUNA and sUST without the considerable bridging costs, risks and complexities experienced on other chains. This better UX should bring Cosmos users into the privacy space. Of course, Secret Network has established cross-chain bridges for Ethereum, Monero, BSC and is currently working on bridging over Bitcoin via Shinobi bridge, as well as in testnet for bridging for Polkadot.
There is tremendous support for both builders and users, when they migrate to Secret. A recently announced $400M of funding for new and existing project teams building on the network will allow teams to bring their products to market with greater support. Community leadership is another catalyst for Secret Network, with the likes of Tor Bair championing Secret Network by actively engaging with community members and large investors, as well as project founders such as Carter Woetzel building promising DeFi dapps (Shade Protocol) on the network.
The Cosmic Cartel have been long-time supporters of “PriFi” in general, and Secret, in particular. Earlier iterations of our thesis can be seen on Messari (Rasheed) and in a hedge fund blog (Rahul), both from September 2021. We see Secret Network as formidable competition for layer 1 privacy, with considerable economic activity migrating through the ease of bridging using IBC.
Next week, we’ll be covering the Secret ecosystem in depth: The state of the network, available DApps, forthcoming web3 applications in the pipeline, and the overall potential of the ecosystem.
