by Josiah Makori

Key Takeaways:

Digital currencies are admired for their anonymity via decentralized transactions and related services. Since the invention of bitcoin (BTC) in 2009, thousands of cryptocurrencies have been issued that share many similarities with BTC. While these cryptocurrencies are decentralized and, to some extent, anonymous, they are not totally private.

For example, if Alice sends Bob 1 BTC, the transaction is permanently recorded on the Bitcoin blockchain using their wallets and not their personal information. The technique only makes the transaction pseudonymous and not anonymous, as anyone who knows Alice and Bob's wallet addresses can access records of their bitcoin transactions.

Likewise, you can easily track every transaction of every token in the Ethereum ecosystem using a blockchain explorer like Etherscan, and if you know someone's wallet address, you'll have access to their entire transaction history or the size of their crypto holdings.

This reality birthed the idea of untraceable cryptocurrencies, known as privacy coins. 

This article delves into privacy coins, their legality, how they work, and the top 10 privacy coins by market cap.

What are Privacy Coins?

Privacy coins are digital assets that obscure on-chain transactions to enhance the anonymity and activities of their users. They are designed to protect the identity and personal information of individuals who use them to transact.

One of the main features of privacy coins is using privacy-enhancing technologies such as stealth addresses and zero-knowledge proofs. Stealth addresses allow you to generate a unique, one-time address for each transaction, making it difficult for other blockchain users to link the transaction to a specific individual. On the other hand, zero-knowledge proofs enable you to prove that you possess certain information without revealing the actual data.

Some of the popular privacy coins include Monero (XMR), Zcash (ZEC), and Dash (DASH). Monero, for example, uses ring signatures and stealth addresses to obscure the identity of the sender and receiver in a transaction. Zcash uses a technology called zk-SNARKs (Zero-Knowledge Succinct Non-Interactive Argument of Knowledge), which allows you to prove the authenticity of a statement without revealing the underlying information. On the other hand, Dash uses a decentralized " masternode " network to obscure the transactions' source.

While privacy coins have been praised for their ability to protect users' privacy, they have also faced criticism from law enforcement agencies and regulatory bodies. Some have argued that they can be used to facilitate illegal activities such as money laundering and drug trafficking. As a result, some countries have taken steps to restrict or ban the use of privacy coins.

Despite the controversy, privacy coins have gained a significant following among crypto users who value their privacy and seek to protect their personal information in an increasingly data-driven world. Whether or not to use a privacy coin is a personal decision that depends on your priorities and risk tolerance.

Are Privacy Coins Legal?

Generally, the use of privacy coins is legal. However, the legal status of these coins varies depending on the country where you want to use them. Some countries may have regulations or restrictions on the use of privacy coins, while others may not.

For example, the use of privacy coins may be more restricted in countries with strict anti-money laundering (AML) laws or where the government has expressed concerns about using such coins for illicit activities, like the US. In these countries, it may be illegal to use privacy coins, even if you're using privacy coins for general purposes, without the intention to evade taxes or engage in illicit transactions.

On the other hand, in crypto-friendly countries or countries with more relaxed regulations, like Malta and El Salvador, the use of privacy coins is less restricted. In these countries, using privacy coins for various purposes, including making purchases, investing, and transferring funds, is legal.

Do note that even in countries where the use of privacy coins is not explicitly regulated, they are likely to still be subject to other laws and regulations, such as those related to money transmission or tax evasion. Overall, the legal status of privacy coins is a complex and ever-evolving issue. As such, you should know the laws and regulations for their use in your specific jurisdiction.

How Do Privacy Coins Work?

Privacy coins leverage a combination of techniques to provide anonymity and privacy for users. Though these techniques can effectively conceal your on-chain footprints and identity, it is essential to note that they are not foolproof and may not provide full anonymity. As such, it's advisable to use privacy coins with the right motives since law enforcers can still catch up with you if you misuse them! 

The first technique often used by privacy coins is called "mixing." It involves using a third-party service (a "mixer," such as Tornado Cash) to break the transaction chain between the sender and recipient of a transaction. When you want to send a crypto like BTC to another user, you send it to the mixing service instead, which runs on smart contracts. The mixing service then uses various techniques, such as shuffling the coins with others in its own liquidity pools or using multiple intermediary addresses to break the link between the sender and the recipient. This makes it difficult for anyone to trace the transaction back to the original sender or recipient.

The other common technique for privacy coins is "stealth addresses." It involves the use of a one-time address that is generated for each transaction. The stealth address is created by the recipient of the transaction and is not linked to their address. You can then send any coin to the stealth address, making it difficult for anyone to trace the transaction back to the recipient.

Apart from mixing and stealth addresses, privacy platforms may also use techniques such as ring signatures and zero-knowledge proofs to provide anonymity for users. Ring signatures allow a group of users to have a shared address, making it difficult for anyone to determine which group member made a particular transaction. Meanwhile, zero-knowledge proofs allow you to prove the validity of a statement without revealing any additional information about it, concealing your identity and transaction details.

Can Privacy Coins be Tracked?

As mentioned, privacy coins are only partially untraceable. While they provide a higher level of anonymity than other cryptocurrencies, they are not entirely anonymous. For example, Monero uses ring signatures to obscure the sender's identity, but this technique is vulnerable to certain attacks that can reveal your identity. 

In September 2020, the United States Internal Revenue Service (IRS) offered a bounty of $625,000 for contractors who could develop tools to help trace monero. This contract was awarded to Chainalysis and Integra FEC. According to a leaked presentation, Chainalysis claimed to provide a "usable lead" in 65% of monero tracing cases. 

In early 2022, a couple, Ilya Lichtenstein and Heather Morgan, were accused of laundering $4.5 billion of stolen cryptocurrency. They had exchanged bitcoins for privacy coins like monero and Dash to avoid traceability, among other obfuscation techniques, like using mixers. While there's no details as to how investigators managed to trace the movement of monero (or if they even traced monero) to link the accounts to the criminals, it remains a possibility. 

However, the ability to track privacy coins is not universal, and the effectiveness of tracking methods varies depending on the specific coin and the techniques used. Some privacy coins may be more resistant to tracking than others, and new technologies and techniques may be developed in the future that makes it even more difficult to track these coins.

Overall, while privacy coins do offer a greater level of anonymity than other cryptocurrencies, they are not completely untraceable. These coins can be tracked, although the extent to which this can be done can vary depending on the specific coin and the methods used.

List of Top 10 Privacy Coins by Market Cap

Ever wondered what the most popular privacy coins are? We've put together a list of some of the biggest privacy coins in the space.

Monero (XMR)

Monero’s XMR was created in 2014 with a focus on privacy and anonymity. Currently, it's the biggest privacy coin with a market cap of $2.6b. XMR is based on a proof-of-work (PoW) mechanism and uses a public ledger to record transactions. One of the critical features of Monero is that it uses a technique called ring signatures to conceal the identities of the sender and recipient of a transaction.

Ring signatures allow a group of users to have a shared public key, with each user having a private key. When a transaction is made, the sender can use the shared public key to create a signature that proves the transaction is valid without revealing which private key was used to generate the signature. Monero also uses stealth addresses and confidential transactions to enhance its users' privacy further.

Zcash (ZEC)

ZEC is a decentralized, open-source cryptocurrency that uses cryptography to provide enhanced privacy for its users. It's the second biggest privacy coin with a market cap of almost $0.5b. ZEC was created in 2016 as a fork of the Bitcoin protocol, with the addition of a privacy feature called zero-knowledge proofs.

Zero-knowledge proofs allow one party (the prover) to prove to another party (the verifier) that a statement is true without revealing any information about it. In the context of Zcash, you can send and receive ZEC without revealing your identity or the amount of ZEC being sent. Although transactions are recorded on a public blockchain, the sender, recipient, and amount of ZEC are all encrypted and can only be decrypted by the parties involved. 

Dash (DASH)

DASH is a digital currency created to improve upon Bitcoin features. It is an open-source cryptocurrency that offers fast, cheap, and private transactions. It is the third largest privacy coin with a market cap of $0.47b.

To achieve anonymity, Dash uses a technique called PrivateSend. PrivateSend works by mixing multiple transactions in the same amount to make it difficult to determine the origin of the funds. Additionally, Dash has a feature called InstantSend, which allows for near-instantaneous transaction confirmation without needing multiple confirmations. This helps to further obscure transaction origins. 

Decred (DCR)

DCR is a privacy coin that uses a decentralized governance system to allow users to make decisions about the direction and development of the underlying protocol. It is based on the Bitcoin codebase and uses the PoW mechanism to validate transactions and add new blocks to the blockchain. DCR has a market cap of $0.28b.

Decred offers users the option to use CoinShuffle++ (CSPP), a mixing protocol to obfuscate DCR coins ownership, where the output adddresses are anonymized with a mixer and there is no link between outputs and inputs. However, this anonymity can be lost if the wallet addresses are reused or if the change outputs are not used correctly. 

Beldex (BDX)

Beldex is a decentralized cryptocurrency exchange (DEX) focused on providing a secure and anonymous platform for buying and selling digital assets. It is built on the Monero blockchain, known for its robust privacy features. Beldex uses ring signatures and stealth addresses to achieve user anonymity. The BDX coin has a market cap of $0.18b.

Mask Network (MASK)

Mask Network is a decentralized, open-source network that aims to provide anonymous and secure communication for users through encryption. Users can encrypt their social media posts, or even send crypto to other Mask Network users through social media. It is built on top of the Ethereum blockchain and utilizes asymmetrical encryption using public and private keys, where content is encrypted with the sender's private keys, and the recipients can use their public keys to decrypt the content. The whole process is decentralized, which further ensures the privacy of its users. MASK has a market cap of $0.15b. 

DigiByte (DGB)

DGB is a decentralized cryptocurrency that was created in 2014 by Jared Tate. It is based on the Bitcoin and Litecoin protocols, but it has some additional features, such as faster transaction speeds and increased security. DGT has a market cap of $0.13b.

DigiByte uses “Dandelion++,” a privacy-enhancement tool for the DigiByte blockchain that hides the IP address of the sender. This keeps the identity of the person sending a transaction anonymous, making DigiByte safer to use. 

Secret (SCRT)

Secret Network (SCRT) is a platform that focuses on data privacy and anonymity. Secret offers private smart contracts with encrypted inputs and outputs, preventing the data of the individuals involved in the smart contracts from being publicly accessible. Account balances and wallet activities are also concealed, preventing front-running attacks, where attackers profit from the prediction that a large buy or sell-off is about to happen from a specific wallet. 

To gain access to the Secret Network, users have to hold SCRT, which is needed for network fees, and can be used for governance and staking as well. 

NuCypher (NU)

NuCypher is a decentralized, open-source protocol that enables secure, privacy-preserving communication and storage of private data on a public blockchain, and has merged with the KEEP Network to form the Threshold Network. It uses a proxy re-encryption service to ensure that private data remains private and encrypted, providing users with dynamic access control and secret management capabilities.

Horizen (ZEN) 

Horizen is a privacy protocol that allows users to send and receive private transactions. It was formerly known as ZenCash. Horizen uses zero-knowledge proofs to achieve anonymity. The technique ensures that a transaction is valid without revealing the transaction's sender, recipient, or amount. 

Conclusion

In conclusion, privacy coins offer a high level of anonymity and privacy for their users, but they also have the potential to facilitate illegal activities. As a result, they have faced regulatory challenges and controversy, as seen in the Tornado Cash incident,, where the protocol was sanctioned in the US due to allegations of laundering the proceeds of cybercrimes. 

Before using privacy coins, do your own research and ensure that using privacy coins is legal in your area. This article is meant for informational purposes and should not be taken as investment advice. 

*This article was updated on 11 Jan to reflect accurate examples regarding the tracking of privacy coins.

https://www.coingecko.com/learn/what-are-privacy-coins-are-they-legal