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Anonymous cryptocurrencies: What they are, how they work and why they are different from regular crypto

Most cryptocurrency users see anonymity as one of its key advantages. The ability to make payments while staying incognito has brought many people to crypto and made it a popular payment method. It quickly became obvious, however, that anonymity in crypto is more of a myth than a reality. This is especially true when it comes to using crypto offline, where any confidentiality ends the moment a seller requires presentation of a passport.

For this reason, many blockchain developers have attempted to create a truly anonymous coin, and some of them have been pretty successful.

What are anonymous cryptocurrencies?

Anonymous cryptocurrencies are networks that hide the transaction data of their users. This means that information about financial transactions on these blockchains – who transferred how many coins to whom, and when – is invisible to observers who are not participating in the transaction.

One of the advantages of a cryptocurrency like this, of course, is the security of users’ personal data.

There are also downsides, which include longer transaction times, increased commissions, close attention from regulators, the refusal of some crypto exchanges to list these coins, and delisting.

Which technologies can achieve anonymity?

Anonymous blockchains use many different cryptographic technologies to ensure the privacy of transactions. Here are some of the most popular ones:

1. Stealth addresses: these are one-time addresses, generated using the Diffie–Hellman key exchange protocol. For every transaction that takes place, a random one-time address is created so that it cannot be associated with the recipient.

2. zk-SNARK (Zero-Knowledge Succinct Non-Interactive Argument of Knowledge): this algorithm allows participants in a transaction to prove the transaction’s validity without revealing identifying information such as the parties involved or their account balances.

The objective of the algorithm is to show that you know the value of “A” without saying what “A” is or presenting any other data. Transactions that use the zk-SNARK technology operate as follows:

  • the “prover” creates two keys (public and private): a “proving key” and a “verification key”;
  • the prover creates a “proof” – a mathematical representation of a particular statement – using the private key, and then sends the proof and public key to the verifier;
  • the verifier checks the authenticity of the proof using the public key, and does not require any additional data.

The proof cannot be used to identify the source data.

3. CoinJoin: this technology is known as a mixer. In essence, it combines several transactions from different people into one transaction. The outputs of this shared transaction are mixed, making it impossible to determine which user owns a given output, and therefore to identify the sender and recipient of each individual payment.

4. Ring signatures: this technology uses a signature generated from multiple signatures taken from a specific group of users. Anybody who is not involved in the transaction will be able to find out that the transaction was signed by someone from the group of users, but won’t be able to pinpoint the individual. The concept of the ring signature dates back to the Middle Ages, when people would sign petitions by placing their signatures in a circle, thereby hiding the identity of the person who initiated the petition.

Monero, Zcash and Dash are among the most popular cryptocurrencies to use the abovementioned (and other) protocols in order to hide the data of transaction participants. Let’s look at them in a little more detail.

Monero (XMR)

Monero and its CryptoNote encryption engine sit at the very top of the pile. User data on this blockchain is private by design, and the network hides everything from transaction participant identities to the amount of crypto transferred. Information about transactions is visible only to senders and recipients – the data is not accessible by third parties.

Monero uses a relatively sophisticated combination of cryptographic technologies. Transaction data is encrypted using stealth addresses, ring signatures, and the RingCT protocol, which allows you to hide transaction amounts.

Monero is a hit on the dark web. The coin’s security is a bugbear for law enforcement agencies and regulators, so they pay special attention to this network.

That being said, it’s worth remembering that although the developers of anonymous coins are constantly looking for new cryptographic protocols to ensure privacy for transaction participants, there can never be 100% anonymity on these networks. A few years ago, vulnerabilities were identified in the Monero mixer, allowing specific transaction inputs and outputs to be linked. Riccardo Spagni, the lead developer of Monero, offered the following comment on the situation:

“Privacy isn’t a thing you achieve, it’s a constant cat-and-mouse battle. There are steps we can take to continue to improve the sampling, but the reality is that this isn’t a solvable problem by just pecking away at it.”

Zcash (ZEC)

Zcash is Monero’s biggest rival, and uses the Zerocash encryption protocol. The main difference between this network and Monero is that privacy settings are optional. Transaction participants can decide whether to make their activities public or hide the data.

Transaction addresses containing the latter “Z” are created when users need anonymity, while “T” addresses are used for public transactions.

Zcash uses the zk-SNARK protocol, which operates according to the principle of zero-knowledge proof, whereby the authenticity of a transaction can be verified without the need for any information about the other transaction participant, or indeed the ability to identify them. The transaction amount is also hidden from third parties.

Another important aspect of transactions on the Zcash network is that transaction amounts are visible to third-party observers when making transfers from secure addresses to public ones, but not when making transfers from a public address to a secure one.

Like Monero, Zcash is far from perfect when it comes to anonymity. In 2020, researchers at Carnegie Mellon University discovered that the network’s privacy is not at the level claimed by the developers, and more than 99% of transactions could in theory be traced. Nevertheless, the researchers acknowledged that the Zcash ecosystem has impressive cryptographic features.

Dash (DASH)

Dash is an anonymous coin, originally known as XCoin and later Darkcoin. It is a fork of Bitcoin. Its creator, Evan Duffield, was convinced that the original cryptocurrency lacked anonymity and attempted to introduce changes to Bitcoin on several occasions, but in the end developed XCoin.

Dash achieves anonymity through the PrivateSend coin mixing mechanism, which is based on CoinJoin technology. The protocol is not implemented by default, and activating it incurs higher commission fees.

Mixing involves the use of random masternodes over a series of rounds, with four rounds set as the recommended number. This hides the connection between the sender and recipient of the crypto, with the masternode owners paying a deposit of 1,000 DASH in order to process transactions and receive rewards .

Dash users can also activate the InstantSend protocol for immediate transactions, but the commission is higher. In this case, a quorum of 10 masternodes decides whether to confirm or reject a transaction.

Fernando Gutierrez, Chief Marketing Officer of the Dash Core Group, gave a comment to Cointelegraph arguing that Dash is not primarily a privacy asset: 

“Dash is a payments cryptocurrency, with a strong focus on usability, which includes speed, cost, ease of use, and user protection through optional privacy.” 

He drew attention to the fact that the Dash team had simply updated the CoinJoin transaction mixing technology that had been introduced by Bitcoin’s developers in 2013.

Conclusion

These and other anonymous coins are not falling out of favour. In fact, they are only growing in popularity, using different data encryption technologies and combining them. Developers are constantly working to increase transaction confidentiality across many networks. Likewise, most users want to maintain anonymity in their cryptocurrency transfers, so they are closely monitoring the efforts of certain blockchain developers when it comes to encrypting their data.