The Case For Privacy Coins

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  • Increasing reliance on electronic payment systems, but their decline in use of physical cash has dire implications for society.
  • Governments plan to issue central bank digital currencies (CBDcs), but their use could threaten individual privacy à la George Orwell’s 1984.
  • Privacy coins, designed to shield user transactions, may be the last resort for citizens amid growing government-sponsored financial surveillance.

Every day, your reliance on physical cash to complete purchases reduces. Why bother carrying notes and coins when you can swipe a card or pay at the tap of a button with an app?

For the average consumer, the rise of electronic cash payments promises greater convenience. Digital payments have also helped spur eCommerce growth by making online purchases easier than ever.

Now, governments want to take this cashless revolution further by introducing central bank digital currencies (CBDCs). CBDCs are tokenized versions of fiat currencies that operate like cryptocurrencies but are backed by the government.

CBDCs will complete the transformation into a cashless society, allowing you to pay for everything directly from your digital wallet. Like cryptocurrencies, CBDCs will be programmable, so central banks can control the supply of tokens in the economy.

Supporters say CBDCs will ease payments for individuals and businesses and increase financial inclusion for unbanked individuals. Besides, digital money is easier to track than physical cash, so CBDCs may enhance monitoring and confiscation of illegal funds.

But there’s a catch. Government-issued digital cash, specifically CBDCs, is a Greek gift—a curse disguised as a blessing. As I explained in a recent post, centrally-controlled digital currencies are tools for unrestrained financial surveillance and social control.

Cryptocurrencies like Bitcoin exist on an open ledger, and anyone can see the history of transactions. You can see details, such as the amount, the time of the transaction, and the parties involved in the transaction.

However, sender and receiver addresses are encrypted, so you can’t possibly get personal information about who sent bitcoins to who. This explains Bitcoin’s description as a “pseudonymous” method of payment.

CBDCs are a different kettle of fish. Although these digital currencies may exist on a distributed ledger like Bitcoin, participants would hardly be anonymous or pseudonymous. Governments will force users to register their information through rigorous Know-Your-Customer (KYC) laws.

The result is something straight out of George Orwell’s 1984. Governments will have the unprecedented ability to track even the smallest transactions that citizens make using CBDCs.

A benign government may wield this power to stop the bad guys—blocking tax evasion attempts, preventing terrorism funding, or cutting off a drug baron’s money supply. But what happens when a less-than-benign government has the power to conduct financial surveillance on a massive scale?

I’ll tell you what can happen. Governments will intrude on financial privacy and dictate what products you can buy with your money. Or worse, governments weaponize money and punish individuals and businesses by blacklisting them from the financial system.

If you think this isn’t possible, then you’re in for a rude shock. Around 80% of central banks are considering a digital currency, with countries already launching CBDCs. And there’s something all agree on: CBDCs will allow for complete monitoring of transactions.

The Fight For Financial Privacy

In the 1993 Cypherpunks Manifesto, Eric Hughes declares: “We cannot expect governments, corporations, or other large faceless organizations to grant us privacy out of their benevolence.” Years later, this statement rings true—governments are on a mission to intrude into the private lives of regular individuals.

The rise of electronic payments, like wire transfers and credit card payments, has allowed law enforcement to track the inflow and outflow of money with alarming ease. Using regulatory pressure, law enforcement can coerce digital payments providers into producing transaction records and unmasking users.

With CBDCs, a government wouldn’t even need to conscript third-party providers into its financial surveillance mission. Every transaction you make will be recorded on a KYC’ed-ledger firmly in control of government-controlled central banks. There simply won’t be any way to hide your financial dealings from the all-seeing eye of Big Brother.

If the move towards a cashless society and CBDCs will become the primary means of exchange, is there any hope for a world where citizens can transact without the prying eyes of a government official?

The short answer is: yes, privacy coins—designed to conceal transaction details—may provide enough financial anonymity for those who want it. The long answer is more complicated, but I’ll start by explaining the idea behind privacy coins.

A Casual Introduction to Privacy Coins

Wei Dai, a famous cryptographer, wrote in 1995:

There has never been a government that didn’t sooner or later try to reduce the freedom of its subjects and gain more control over them, and there probably will never be one. Therefore, instead of trying to convince our current government not to try, we’ll develop the technology…that will make it impossible for the government to succeed.

Wei Dai understood a fundamental principle of modern politics: if left unchecked, nation-states would run rampant and subject the citizenry to totalitarian control. He believed people could either appeal to governments and avert this possibility, or they could build technology to nullify any attempt to surveil and control citizens.

Dai, a gifted cryptographer and notable Cypherpunk, was unequivocal about using cryptography to stifle invasion of privacy. He created b-money, one of the earliest cryptocurrencies, and his cryptography work was referenced in the Bitcoin whitepaper.
Privacy coins are a product of the thinking Wei Dai and other cryptographers, like Adam Back and Eric Hughes espoused. Although their implementations vary, privacy coins have a single overarching objective: prevent the correlation of currency transactions with user identities.

Privacy coins use a motley of cutting-edge technology to achieve transaction anonymity, including zero-knowledge proofs, ring signatures, and stealth addresses. Another tactic is to mix cryptocurrency transactions to prevent anyone from linking individual transactions to specific users.

Monero, one of the earliest privacy coins, uses ring signatures to protect user privacy. Here’s a useful explanation of ring signatures from Monero itself:

A ring signature makes use of your account keys and a number of public keys (also known as outputs) pulled from the blockchain using a triangular distribution method. Over the course of time, past outputs could be used multiple times to form possible signer participants.

In a “ring” of possible signers, all ring members are equal and valid. There is no way an outside observer can tell which of the possible signers in a signature group belongs to your account. So, ring signatures ensure that transaction outputs are untraceable.

In plain English, Monero allows multiple addresses (including yours) to sign a transaction, preventing anyone from correlating the transaction with your account. It’d be simply impossible to pin the transaction on any address in the group.

Launched in 2016, Zcash uses an implementation of zero-knowledge proofs called zk-SNARKS, which is short for “Zero-Knowledge Succinct Non-Interactive Argument of Knowledge.” Per Zcash, “zero-knowledge proofs allow one party to prove to another (the verifier) that a statement is true, without revealing any information beyond the validity of the statement itself.”

With Zcash, users can perform private or “shielded” transactions that disclose little information to outsiders. Zcash provides two keys—a “view key” and a “spend key.” While the spend key allows the holder to spend funds, the view key can be shared to allow another party to view select transaction details.

Then there’s Mimblewimble released by a pseudonymous developer named Tom Elvis Jedusor in 2016. Mimblewimble isn’t a coin, but a privacy-enhancing software that can be adapted to other cryptocurrencies. Beam and Grin are two major coins using Mimblewimble to protect user privacy.

Mimblewimble relies on several features for its privacy capabilities. It uses Confidential Transactions to conceal transaction amounts and CoinJoin to mix several transactions into one to prevent external trailing of transactions. The protocol also uses Dandelion protocol, which allows users to transact without revealing their addresses on the blockchain.

While cryptocurrencies like Bitcoin were conceived as peer-to-peer, anonymous money, their design limits user privacy. Sure, your Bitcoin address doesn’t have your name in it―but anyone can link a node to your IP address and uncover your identity. And there are companies like Chainalysis and Elliptic developing software that’ll make blockchain deanonymization a trivial task.

As they implement more cutting-edge technology, privacy coins are more resistant to deanonymization attempts. This doesn’t mean Monero and Zcash are completely anonymous, but they are your best shot at protecting your privacy―especially if CBDCs become a thing.

Resisting the Panopticon

In the 18th century, English philosopher Jeremy Bentham introduced the “Panopticon” into modern thinking. The Panopticon is described as a circular prison with cells arranged around in a central tower. From the tower, prison wardens can see every cell in the area.

Although watching every cell may be infeasible for the guard, inmates in a panopticon must err on the side of caution and act like they’re being monitored. This leads them to self-regulate and avoid acting against the wishes of the authority for fear of punishment.

Bentham’s Panopticon is a metaphor for a totalitarian state where rulers effectively control their subjects through unrestrained surveillance. This is already a trend in countries like China, where citizens self-censor for fear of being hunted by government agents.

Government-controlled digital money is set to strip away every right that people have to spend their money however they want. This dystopian future may seem far away, but you might wake up one day and realize it’s here already.

Decentralized, privacy-focused cryptocurrencies may well be our last hope of resisting the Panopticon and preserving our liberties. Just like good old cash, anonymous currencies can preserve the identity of holders.

Of course, you can expect governments to continue their rollout of CBDCs, but their use will be minimal―especially if anonymous currencies take off. It may not seem apparent now, but financial privacy is a right: people deserve the freedom to transact freely and privately, without a third-party monitoring or censoring transactions.

To conclude, here’s another quote from Wei Dai:

But even if you do not believe the above [possibility of government surveillance] is true, think about it this way: If you have a certain amount of time to spend on advancing the cause of greater personal privacy (or freedom, or cryptoanarchy, or whatever), can you do it better by using the time to learn about cryptography and develop the tools to protect privacy, or by convincing government not to invade your privacy?