The advent of Bitcoin has proved to be a key landmark in the way that money is thought about because it has demonstrated that it is possible to create an entirely decentralized incorruptible and spendable digital currency. However, while taking into account all the successes that Bitcoin has managed to achieve, the digital currency has shown itself to be weak in one area in particular: privacy. This has resulted in the emergence of privacy coins that threaten Bitcoin’s market dominance.
Privacy and fungibility
One attribute that is often credited to Bitcoin is being an anonymous digital currency, however, this is incorrect. Bitcoin, at best, is more pseudonymous than it is anonymous. It is pseudonymous because user identity on the Bitcoin blockchain is obscured, as users’ names are substituted for public addresses. This protection is not one that can be described as being truly anonymous, because if an individual can attach a Bitcoin address to a user, then it suddenly becomes possible to monitor the transactional activity of that user.
The privacy weaknesses found in Bitcoin also produce issues about fungibility. Fungibility is a concept that can be defined as the ability to exchange a unit of a commodity or good. For example, the U.S. dollar is a fungible fiat currency because one unit e.g. one dollar can be exchanged for another dollar bill. The problem of fungibility becomes more acute when one considers the below example:
Within the Bitcoin ecosystem, if it becomes known to network participants that a Bitcoin address is engaging in illegal activity, then the Bitcoin housed within that wallet address may be regarded as being “tainted” by the wider community. This might create a situation in which other participants i.e. merchants refuse to accept that tainted Bitcoin, so as not to fund further illegal activities.
Therefore, in this scenario, Bitcoin would effectively be less fungible, as it would become considerably harder to exchange one unit of Bitcoin. More robust privacy features would resolve this fungibility concern, because if an individual cannot determine the origins of received funds on the blockchain then they have no knowledge as to its history.
Privacy coins: Monero, PIVX, Zcash, and Dash
Bitcoin’s privacy weaknesses have encouraged the development of privacy-focused cryptocurrencies, with the popular privacy coins being: Monero, Zcash, and Dash.
Monero was launched in 2014 and utilizes three distinct technologies to achieve true user anonymity on the blockchain.
Ring Signatures – Monero ring signatures are intended to protect user privacy on the input side of a transaction. Ring signatures operate by fusing a group of possible signers to produce a distinctive digital signature that possesses the capability of executing a transaction. The result is a scenario in which it is extremely difficult for third-parties to determine the individual that actually initiated the transaction.
Ring Confidential Transactions (RingCT) – Monero RingCT functions by obfuscating the value of funds on the Monero blockchain. Monero achieves this by employing a cryptographic proof, which shows that the input of a transaction is equivalent to its output. It is important to note that this is accomplished without revealing the value of the actual transaction.
Stealth Addresses – This third privacy feature provides anonymity to user addresses on the Monero blockchain. Stealth addresses necessitate that a sender in a transaction creates one-time addresses for every transaction on the recipient’s behalf. This then makes it difficult for third-parties to link transactions to the recipient’s actual address.
PIVX, which stands for Private Instant Verified Transaction(X), is another privacy coin that utilizes Zerocoin, a protocol that provides transactional privacy for users on the PIVX blockchain. PIVX’s implementation of Zerocoin makes viewable PIV coins anonymous, to preserve user privacy and fungibility of the native asset. This is achieved via the use of the second-tier PIVX masternode.
Zcash is another privacy-centric cryptocurrency that was founded by Zooko Wilcox. The privacy feature that Zcash is known for is the cryptographic zero-knowledge proof that it employs, also known as zk-SNARKs. This privacy feature operates by encrypting transaction data on the blockchain. The feature can determine the accuracy of the encrypted transactional data without having to reveal it.
Dash is another popular privacy-focused digital currency that is intended to provide privacy functionalities to users on its blockchain. It does this primarily through the use of its PrivateSend function. This operates as a coin-mixing service that mixes a user’s funds with others on the network, which then makes it difficult to identify where mixed funds originated from.
It is undoubtedly the case that Bitcoin is the most dominant digital currency currently operating in the space. However, this dominance has seen erosion, as more digital currencies offer innovative features that cannot be found in Bitcoin. This is a scenario that has played out, with privacy coins such as Monero, PIVX, Zcash, and Dash achieving some levels of success.