What Are Privacy Coins: Understanding Their Role and Importance

2 Dec 2023 by Harry Newman 7 min read

What are privacy coins? Privacy coins are a version of cryptocurrencies that offer users privacy and anonymity in their transactions.

Privacy coins use sophisticated cryptographic algorithms along with technology to mask the sender, receiver, and amount sent in a transaction.

What Are Privacy Coins?

In the dynamic world of cryptocurrencies, privacy coins have emerged as a notable development, addressing the growing concerns about privacy and anonymity in digital transactions.

Unlike Bitcoin, where transactions are recorded on a public ledger accessible to everyone, privacy coins ensure that only the parties involved in the transaction have visibility of the transaction details.

This level of anonymity, however, has raised concerns.

Privacy coins can potentially be used for money laundering and other illicit activities due to the anonymity they offer.

As a result, some European countries have initiated steps to ban privacy coins like Monero, with more detailed information available here.

The challenge for privacy coins lies in balancing their utility with the negative perception they might garner. As many people still ask the question ‘what are privacy coins?’

Despite potential misuse, privacy is a fundamental aspect of cryptocurrencies and decentralisation.

Privacy coins not only provide an essential option for those seeking to keep their transaction information confidential but also serve as a crucial alternative to traditional financial systems.

Being decentralised, privacy coins are not subject to control by any government or central authority, embodying the ethos of financial independence.

This independence is crucial, as it allows individuals to conduct private transactions when necessary, offering a level of financial autonomy not typically available in traditional banking systems.

This aspect of privacy coins makes them a valuable component of the broader cryptocurrency landscape, offering users the discretion and independence they seek in their financial transactions.

How Do Privacy Coins Work

Privacy coins use complex algorithms that mix multiple transactions, making it difficult to trace the sender or receiver of the coins.

This can be to protect anonymity and to keep your information secure.

Sometimes hiding information is important.

For example, suppose you are running a business and suppliers can see your public wallet. In that case, it gives them an edge in negotiating new rates as they can see how much funds you hold and any other data about the business.

There are several techniques privacy coins use to ensure anonymity and security, these are:

Coin Mixing

Coin mixing represents a technique used to obscure the source and destination of cryptocurrency transactions. This method enables users to conceal the specifics of their transactions by intermingling them with other transactions across various addresses, thereby rendering the transaction paths untraceable and complicating the tracking of fund flows. Companies specialising in coin-mixing software act as intermediaries, facilitating the exchange of cryptocurrencies between parties wishing to maintain privacy. These services, however, come at a cost. For instance, if individual A wishes to send Ethereum (ETH) to individual B without leaving a traceable record, they might opt to employ a coin mixing or tumbling service. In this process, the service provider blends individual A's transaction with several others, pooling a larger collective sum of the same cryptocurrency. Subsequently, the service disburses the appropriate amount to individual B, completing the transaction while maintaining anonymity.

Stealth Addresses

Stealth addresses are a privacy technique employed by certain cryptocurrencies, designed to enhance transaction anonymity. These are singular, one-time-use addresses created for every individual transaction, effectively preventing external parties from associating transactions with a particular address. For instance, suppose individual A wishes to transfer Monero (XMR) to individual B. In this case, they can utilise a stealth address to conceal the transaction's details. Individual A generates this unique address specifically for the transaction, directing the XMR to it. Subsequently, when individual B is ready to receive the XMR, they provide individual A with a newly generated stealth address for the transaction.

Zero-Knowledge Proof

Zero-knowledge proof is a technique frequently used by privacy-focused cryptocurrencies. This method, also known as zero-knowledge protocol (ZKP), enables two parties, traditionally referred to as the Prover and the Verifier, to authenticate specific information shared between them without disclosing any supplementary data beyond confirming the information's absolute accuracy. For instance, consider individual A wanting to transfer Zcash (ZEC) to individual B. They can employ a zero-knowledge proof to validate the transaction's legitimacy while keeping the details about the sender, receiver, and the transaction itself confidential. Individual A can generate proof that verifies they possess the necessary funds for the transfer to individual B, yet this proof does not expose any specific transactional information.

Ring Signatures

Ring signatures stand as a crucial method adopted by privacy-centric cryptocurrencies. This approach is applied during the execution of a transaction. It involves a collective of users who each sign off on a message, it is impossible to tell which specific user in the group has signed it. For example, should individual A wish to transfer Monero (XMR) to individual B, they could employ a ring signature to conceal the details of this transaction. In this process, individual A is put into a group comprising other Monero users, allowing their transactions to be intermixed with others. While this collective group endorses the transaction with their signatures, it remains impossible to identify the exact user who initiated the transfer of XMR to individual B.

Privacy Coins Examples

Monero (XMR)
Established in 2014, is built upon the CryptoNote protocol. This protocol incorporates ring signatures, a feature that obscures the transaction source, enhancing privacy.

This mechanism enables users to blend their transactions with others, effectively rendering the identification of senders or receivers unfeasible. Additionally, Monero leverages stealth addresses for transactions. These are distinctive, single-use addresses created for each transaction, which thwart third parties' attempts to associate transactions with specific addresses.

The primary goal of XMR is to facilitate private and anonymous transactions. Its anonymous creators prioritise privacy and security, with a secondary focus on usability and functionality.

Zcash (ZEC)

Introduced in 2016, employs zk-SNARKs, a form of zero-knowledge proof technology.

This advanced method permits users to authenticate the legitimacy of their transactions without revealing any details about the sender or receiver, thus bolstering user privacy. Zcash, a derivative of Bitcoin, maintains a capped total supply of 21 million units.

While transactions via Zcash are recorded on a public blockchain, the default setting keeps the sender’s and recipient’s addresses, as well as the transaction amount, confidential. Unlike Monero, Zcash offers the flexibility to disclose transaction details for purposes such as audits or regulatory compliance, providing an additional layer of versatility in its privacy features.

Oasis Network (ROSE)

Operates as a privacy-centric and scalable Layer-1 blockchain. Melding together the benefits of high transaction capacity and minimal gas fees with a secure framework, aiming to lay down a robust groundwork for Web3.

To safeguard the constant privacy of user data, the Oasis Network has developed a Trusted Execution Environment (TEE).

This TEE constitutes a protected segment within the main processor, ensuring that all code and data processed within it remain confidential and secure. This approach not only preserves privacy but also instils a heightened degree of trust in the code executed by the network.

A view of the top privacy coins by market capitalization can be found here.

Final Thoughts

Not all privacy coins are the same, a privacy coin that might work for one individual may not work for another, so finding the right one for you is important.

Despite the bad reputation of privacy coins, they are essential in making sure users can conduct safe and secure transactions.

While it might be true that privacy coins are associated with criminal activities and money laundering, it is also true that fiat currencies and banks are also used for these activities.

Privacy coins are not criminal or illegal to use, and the vast majority using privacy coins are not conducting any criminal activities.

Users value their financial independence and privacy. It is likely that privacy coins will play an important role in enabling financial freedom and independence for users around the world.

FAQ

What Are Privacy Coins?

Privacy coins are a version of cryptocurrencies that offer users privacy and anonymity in their transactions.

Privacy coins use sophisticated cryptographic algorithms and technology to mask the sender, receiver, and amount sent in a transaction.

How Do Privacy Coins Work?

Privacy coins use complex algorithms that mix multiple transactions, making it difficult to trace the sender or receiver of the coins. Using methods such as coin mixing, stealth addresses, ring signatures and zero-knowledge proofs.

Why Are Privacy Coins Important?

Privacy coins offer users an alternative to the traditional financial system. They are decentralised, which means they are not controlled by any government or central authority. In order to have financial independence, it is important to be able to conduct transactions that are private if necessary.

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