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Understanding Bitcoin and Privacy Coins
The inception of Bitcoin has proved to be an important monetary landmark, because it has shown that a peer-to-peer digital and spendable currency can be achieved.
However, for all the successes that Bitcoin has achieved, it has proved weak in one particular area: privacy.
Privacy and Fungibility
Bitcoin is often described as being a private and untraceable digital currency, however, this is a fallacy. At best, Bitcoin is more pseudonymous than it is private. Bitcoin is pseudonymous because user identity on the blockchain is masked, as usernames are substituted for public addresses. However, this protection is not truly private as some would describe it as being. If you or I could link a bitcoin address to an individual, then it is suddenly possible to monitor the funds that are moving into and out of that address. This would mean that you or I could find out the transactional habits of that individual, and also perhaps other third-party individuals that are transacting with that same Bitcoin address.
Bitcoin’s weakness in relation to privacy also brings up issues of fungibility. Fungibility can be defined as the ability to exchange a unit of a commodity or good. For example, the U.S. dollar is fungible because $1 can be exchanged for another $1 bill. Potential problems of Bitcoin’s fungibility can be made clear if one considers the following example:
If it becomes known to participants operating on the Bitcoin network that a particular Bitcoin public address engages in illegal activity, then the Bitcoins residing in that address may be regarded as being ‘tainted’. It may be the case that merchants and other individuals refuse to accept those ‘tainted’ bitcoins so as not to fund further illegal activities.
Thus, in this example, this would make Bitcoin less fungible, as exchanging one unit of bitcoins would become considerably harder. Stronger privacy features would solve issues of fungibility because, if one cannot determine the origins of funds on a blockchain, then they have no insight as to its history. Meaning that merchants and other participants on the network likely will accept funds, even if they have been involved in illegal activity.
Monero, Zcash and Dash
Bitcoin’s weakness in privacy has spurred the development of privacy-centric cryptocurrencies, with the more well-known projects being: Monero, Zcash and Dash.
Monero is a privacy-focused cryptocurrency that was launched in 2014. Monero provides user privacy on its network by use of three technologies:
Ring Signatures – Monero ring signatures safeguard user privacy on the input side of a transaction. Ring signatures function by merging a group of possible signers in order to produce a distinctive digital signature that is capable of executing a transaction. This then makes it extremely difficult for third-parties to determine the individual that actually authorized the transaction.
Ring Confidential Transactions (RingCT) – Monero RingCT works by obscuring the value of funds on the blockchain. This is done by employing a cryptographic proof that demonstrates that the input of a transaction is equal to its output. Importantly, all of this is done without having to reveal the value of the transaction.
Stealth Addresses – This Monero feature provides privacy to user addresses on the blockchain. Stealth addresses require that a sender involved in a transaction create one-time addresses for every transaction on the recipient’s behalf. By doing this, it makes it hard for outside third-parties to link any transaction to the recipient’s actual address.
Zcash is an equihash algorithm-based cryptocurrency that was founded by Zooko Wilcox. The privacy feature that Zcash is well-known for is its innovative cryptographic proof known as zk-SNARKs (Zero-Knowledge Succinct Non-Interactive Argument of Knowledge’. Zcash’s zero-knowledge proofs function by encrypting transactional data that is contained on the Zcash blockchain. It can then determine that this data is accurate without having to reveal any of it. This Zcash feature is optional, meaning that users are given the option to opt in or out of it.
Dash is another well-known digital currency that is designed to provide privacy functionalities to users on its blockchain. This is done by use of Dash’s PrivateSend function, that serves as a coin-mixing feature on the network. PrivateSend works by mixing user funds with others on the network. This is intended to make it difficult for third parties to determine where funds originated from.
Bitcoin has without a doubt proved to be the most dominant digital currency over the past few years, however, it has not addressed user privacy issues. In a climate in which privacy is increasingly becoming an important issue, privacy-centric cryptocurrencies such as Monero, Zcash and Dash are emerging as valid contenders to challenge Bitcoin’s dominance.