This is the 3rd article in the series of — How to Find Your Next Cryptocurrency Investment?
The chorus for privacy seems to be increasing every day. Worldwide, people are concerned about their personal details being recorded by search engines and social media websites. They, rightfully, demand that their data be kept private and secure. The field of Bitcoins and other cryptocurrencies is no different either.
As these cryptocurrencies have gained more attention and acceptance, users are starting to get uncomfortable by a giant digital ledger publicly available for all to see.
A recent study by Steven Goldfeder at Princeton University found that 54 out of 130 bitcoin-accepting websites like Microsoft and Overstock experience intentional or unintentional data leaks to third parties. In 60% of the cases, these data leaks can reveal the buyer’s public key. Once that is known, all the past and future transactions of that buyer can be conveniently tracked.
Here, the concept of privacy coins come into play. Privacy coins are not very different from Bitcoin. In fact, they too are cryptocurrencies and exhibit all its properties. However, they differentiate themselves by taking steps to protect the identity of the receiver and the sender. In case of Privacy coins like Monero and ZCash, it is exponentially more difficult to know accurately the identity of the sender and the receiver.
How Do Privacy Coins Work?
Privacy Coins do not have a particularly common working principle. However, they do have a common working objective. All privacy coins intend to hide the identity of the sender and the receiver. They try to increase the privacy of the entire system. To this end, they use a variety of methods, all of which are very different from one another.
Some currencies hide the identity of the sender by mixing the transfer amount with other transactions in the same currency. Other currencies use a pool of senders to send the currency to another individual. Still, some currencies use predefined strings to check the accuracy of transactions without revealing the transactions themselves.
Hence, many different privacy coins deploy different mechanisms to safeguard their users’ privacy. In the next few paragraphs, we will know more about the different currencies and the working principles employed by them. Further ahead in the article, we will delve into the depth of these working principles and how exactly do they work to secure users’ privacy.
Privacy Coins Working Principle
After a point, it is very difficult to differentiate a privacy-centered cryptocurrency from a general non privacy centered cryptocurrency. However, we will take those cryptocurrencies that are serious about user privacy and preferably have it as one of their stated goals. It is advisable to talk about those who have grown over the years and achieved a respectable market capitalization.
Taking these factors into consideration, we have a number of currencies like Monero, Dash, ZCash, Verge, Bytecoin, Bitcoin Private, PIVX, ZCoin etc. From these cryptocurrencies, three stand out as front-runners when we talk about privacy coins. They are Monero, Dash and ZCash.
Each of these coins uses a different method to hide the identity of their consumers. Each of them has, consequentially, faced varying amounts of success. Lets us take each of them and check out their working principles.
#1. Monero (XMR)
Monero is probably the most popular and most secured of the three. Its encryption structure rests on three pillars:
a. Stealth address to protect the recipient.
b. Ring transactions to protect the identity of the sender.
c. Ring Confidential transactions to hide the amount of the transaction.
Due to this strong three layered encryption structure, Monero is often called an opaque or semi transparent cryptocurrency.
We know you haven’t been able to grasp any of the terms mentioned above. Don’t worry, we will cover them in much more detail later on.
#2. ZCash (ZEC)
This currency uses Zk-SNARKs or Zero Knowledge Succinct Non Interactive Arguments for Knowledge. It is a system of proof which helps verify a transaction without knowing about the transaction itself. Don’t worry, we will discuss more about this later on.
#3. Dash (DASH)
Dash uses a technology called CoinJoin, wherein two or more transactions of the same amount are joined and then distributed. This way no one will be able to guess which sender gave money to which recipient.
Explanation Of Working Principles
Now, let us take these working principles one by one and try to get a good grasp on them.
1. Ring Transactions: This technology used by Monero, involves creating a pool of 5 or more senders instead of 1. Among these 5 senders, only one is the actual sender while the other 4 or more senders are decoys. For an outsider, all of these senders have an equal and valid chance of sending the money, that is, executing the transaction. Hence, the outsider is unable to understand the true identity of the sender.
Moreover, it is mathematically very difficult to get to the identity of the sender by knowing the output produced. This way, Monero conceals the identity of the sender.
2. Stealth Addresses: Used in Monero, these Stealth Addresses help in maintaining the confidentiality of the receiver. In Monero, each user has two public and two private spend and view keys. Hence, in total, a user has four keys. While sending money, the sender uses the recipient’s public spend and view keys to create a one time public key. This one time public key, in turn, creates a one time public address. Now, the sender sends the money to this public address. Note that it does not send the money to the recipient.
The recipient, on his part, scans Monero’s blockchain for this transaction. Once it gets the transaction, it uses its private spend key to create a one time private key. Using this private key, it retrieves the coins from the one time public address where the sender had sent the coins. This way, no one gets to know about the recipient’s identity.
3. Ring Confidential Transactions: Initially, Monero used to hide the identity of the sender and the receiver. The transaction amount, on the other hand, was broken into known denominations, which was known to everyone. Hence, everyone could get to know about the value of the transaction.
In January 2017, Monero implemented Ring CT, a new technology to preserve confidentially the amount of the transaction. In Ring Confidential transactions, two or more transaction amounts combine to create a single transaction amount. You can think about Ring CT as the application of ring transactions to transaction amounts. The only difference is that ring transactions group senders while Ring CT groups transactions amounts. Hence, individual payments can no longer be deciphered.
4. CoinJoin:This is the technology employed by Dash. It is actually a very simple concept and closely related to the Ring CT. In CoinJoin, two or more transactions of the same amount are combined and then distributed among the recipients. So, if A and B were to pay $10 each to C and D, their payment would be clubbed into one $20 coin and then paid to C and D individually. This way, we know that C and D received $10 each. However, who paid the money to whom cannot be deciphered. On a large scale, this makes spotting individual identities many more times difficult.
5. Zk SNARKs: Used by ZCash, Zk SNARKs has gained a lot of momentum in recent times. Simply put, Zk SNARKs is a technique by which one can verify the veracity of a transaction without knowing the transaction itself. The math behind it superbly complicated and is probably a topic for another day. To get an idea, consider that a transaction is checked by generating hash codes. So, instead of checking the number and the hash code, Zk SNARKs will simply prove that a number can exist for a particular hash. Hence, the transaction can be authenticated without revealing its contents.
Applications Of Privacy Coins
Privacy Coins are a relatively new concept and have only recently started gaining traction. The most popular privacy coins are worth only a fraction of one Bitcoin in market cap. However, they have been increasingly becoming more relevant. Some applications of privacy coins are:
1. High Net Worth Individuals: Wealthy people find privacy coins especially satisfying. They prefer the anonymity present in privacy coins for several reasons. For one, they do not usually want others to know how wealthy they are. Then, concealing their wealth helps to keep thieves at bay. Otherwise, their public IDs and private wallets would suddenly become prime targets for digital hackers.
2. Coin Exchanges/Payments: At the end of the day, Digital coin exchanges have to bear the brunt of users. They are the ones who have their credibility at stake. For them, privacy coins are better than other regular cryptocurrencies. Privacy coins make it much easier to secure user information and prevent digital malpractices.
3. Digital Coin Administrators: This facet of privacy coins has recently come into light. Privacy coins guarantee anonymity to the user. That we know. However, privacy coins also help in preserving fungibility i.e. in keeping all coins of a currency at an equal value without knowing its source. This may sound simple but it actually isn’t. Would you like to use a Bitcoin used by a famous celebrity or that used by a criminal? In fact, many forums simply refuse to accept Bitcoins tainted by criminals. In these cases, keeping transaction data private helps in keeping all units of the cryptocurrency valid and equal.
The Final Words
Again, cryptocurrencies are a revolutionary concept. Never has anything of this kind been done before. However, they are now getting worldwide attention. They are no more used by computer geeks. They are used by thousands of people and accepted by hundreds of corporations. Together, they are worth billions of dollars.
Celebrities or wealthy people cannot be expected to transact through a currency which records their payments forever on a public ledger. Similarly, governments can’t stay quiet while criminals use these cryptocurrencies for their transactions. Cryptocurrencies will have to take many giant steps before they become mainstream. The concept of privacy coins is just one such step. And, a very good step at that.
The next article in this series will be on — Smart Contracts and dApps
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