Many people use cryptocurrency for transactions because it is pseudonymous. However, unlike regular cryptocurrencies, privacy coins have advanced features that keep transactions untraceable and confidential. In this article, we’ll break down how anonymous cryptocurrencies work, why they’re gaining attention, and their impact on user privacy and regulatory compliance.
What are anonymous cryptocurrencies?
Anonymous cryptocurrencies, also known as privacy coins, are a type of digital currency. They keep users' identities and transactions private and secure. These coins use advanced cryptography to hide transaction details, making them more secure and confidential. Transaction details on these blockchains—sender, recipient, date, amount—are invisible to external observers.
Here are the main features of privacy coins:
Anonymous. Privacy coins hide the identities of both the sender and receiver, making it difficult to trace transactions back to specific individuals.
Untraceable. Transactions made with privacy coins are difficult to trace. This prevents third parties from tracking the flow of funds.
Advanced cryptography. Anonymous coins use special techniques like stealth addresses, ring signatures, and zk-SNARKs to protect transaction details. Stealth addresses create a unique address for each transaction. Ring signatures combine a user's account keys with public keys from the blockchain. This makes it very hard to connect transactions to a specific user. zk-SNARKs allow verification without revealing sensitive data.
How do anonymous cryptocurrencies work?
As we've just discussed, anonymous blockchain technology uses many different cryptographic technologies to ensure the privacy of transactions and secure communications. Here are some of the most popular ones:
Stealth addresses are one-time addresses generated using the Diffie–Hellman key exchange protocol. A random one-time address is created for every transaction, so it cannot be associated with the recipient.
zk-SNARK (Zero-Knowledge Succinct Non-Interactive Argument of Knowledge). This algorithm lets people in a transaction prove it is valid. They do this without showing personal details, like who is involved or their account balances.
The algorithm's objective is to show you 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 makes a proof, which is a math representation of a specific statement. They use their private key and send the proof along with the public key to the verifier.
- The verifier checks the proof's authenticity using the public key and does not require any additional data.
Zk-SNARKs require a lot of computing power. They also need a trusted setup process, which can be a weak point.Mixing or Shuffling involves combining multiple transactions to conceal their origins and destinations. Mixing is quite easy to set up and can effectively obscure transaction origins. However, this approach often depends on trusted third parties and doesn't offer as strong guarantees of anonymity as other methods.
Ring signatures. This technology uses a signature generated from multiple signatures of a specific user group. External observers will be able to see that the transaction was signed by someone in a group of users but won't be able to identify the individual.
The idea of ring signatures dates back to the Middle Ages. Back then, people signed petitions by writing their names in a circle. This hid the identity of the person who started the petition.
Ring signatures are simpler than zk-SNARKs and do not require a trusted setup, making them easier to implement. However, they offer less robust anonymity guarantees compared to zk-SNARKs, as the size of the anonymity set can limit the effectiveness.
Monero, Zcash, and DASH are among the most popular cryptocurrencies that use these protocols to conceal transaction participants' data. While privacy coins provide a secure and private transaction process, they also face significant challenges. These include increased regulatory scrutiny, potential exposure to future technological advancements such as quantum computing, and less liquidity in crypto exchanges.
Top anonymous cryptocurrencies of 2024
This section highlights the top anonymous coins available in the industry today.
Monero (XMR)
Monero and its CryptoNote encryption engine are at the 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. Transaction information is visible only to senders and recipients—the data is inaccessible to 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 popular on the dark web, and its security has raised concerns among law enforcement and regulators who closely monitor the network.
Developers of anonymous coins are working hard on new privacy methods. However, it's important to remember that these networks can never be completely anonymous. Flaws were found 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. We can take certain steps to continue to improve the sampling, but the reality is that this isn’t a solvable problem by just pecking away at it.”
Why doesn't Tangem Wallet support Monero (XMR)?
While we prioritize security and privacy, there are specific challenges with supporting Monero due to its unique cryptography, such as the RingCT protocol with ring signatures. These differ significantly from standard cryptographic schemes, and adapting them to the Tangem card’s secure hardware presents certain obstacles.
Monero transactions also require extra data, like multiple fake inputs, to ensure privacy, increasing the Tangem card's computational and storage demands.
Our current card architecture is highly optimized for other currencies. We have been carefully evaluating the possibility of supporting Monero. While not impossible, substantial changes would be needed, with risks outweighing benefits.
Another challenge is that Monero's design requires the app to handle blockchain synchronization and transaction preparation differently. Offloading certain tasks to external services could compromise the privacy features Monero users expect, something we are eager to avoid.
Tangem continues to explore how we can enhance support for a wide range of cryptocurrencies. However, Monero remains outside our list of considered coins for now due to the technical intricacies involved.
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 publicize their activities or hide the data.
Transaction addresses containing the letter “Z” are created when users need to be completely anonymous, while “T” addresses are used for public transactions.
Zcash uses the zk-SNARK protocol, which functions based on the concept of zero-knowledge proof. This means that the validity of a transaction can be confirmed without requiring any information about the other party involved in the transaction or the ability to identify them. The transaction amount is also concealed from third parties.
When making transfers from secure addresses to public ones, transaction amounts are visible to third-party observers. However, transaction amounts are not visible to third-party observers when transferring from a public address to a secure one.
Like Monero, Zcash is not the ideal anonymous token. 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, originally known as XCoin and later Darkcoin, is an anonymous cryptocurrency created by Evan Duffield. Duffield aimed to improve Bitcoin's anonymity and eventually developed XCoin.
Dash achieves anonymity through the PrivateSend coin mixing mechanism, which is based on CoinJoin technology. The system does not implement the protocol by default, and activating it incurs higher commission fees.
Mixing involves using random master nodes over a series of rounds, with four rounds being the recommended number. This hides the link between the sender and receiver of the crypto. Masternode owners pay a deposit of 1,000 DASH to process transactions and earn rewards.
Dash users can activate the InstantSend protocol for immediate transactions, but the commission is higher. In this case, a quorum of 10 master nodes decides whether to confirm or reject a transaction.
Fernando Gutierrez, the Chief Marketing Officer of the Dash Core Group, spoke to Cointelegraph. He argued that Dash is not mainly 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 pointed out that the Dash team had updated the CoinJoin transaction mixing technology, which Bitcoin’s developers first introduced in 2013.
How regulators oppose anonymous cryptocurrencies
Privacy coins create major challenges for meeting anti-money laundering (AML) and know-your-customer (KYC) rules. These rules aim to prevent illicit activities. They require users to confirm their identities and monitor transactions for any suspicious actions. Privacy coins, with their focus on anonymity, make it hard for crypto exchanges and services to stay compliant with these laws.
Regulators are looking into different solutions to manage these risks:
- Banning privacy coins. Some countries may decide to ban privacy coins on regulated exchanges to reduce access.
- Tightening KYC/AML rules. Exchanges that handle privacy coins may have to follow stricter KYC/AML requirements for better oversight.
- Labeling as Anonymity-Enhanced Cryptocurrencies (AECs). This label could lead to more monitoring and reporting obligations for these coins.
In June 2022, the Financial Action Task Force (FATF) updated its guidance for virtual assets. It urged countries to consider the money laundering and terrorism financing risks associated with anonymous coins and implement measures to address them.
Different regions have taken varied approaches to regulating privacy coins:
- Japan. Japan has banned anonymous coins over concerns about their misuse for illegal activities.
- South Korea. Privacy coins are banned on crypto exchanges in South Korea.
- United States. The U.S. has not banned privacy coins but has taken legal action against services like Tornado Cash that mix anonymous coins.
- European Union: The EU's MiCA regulation has added stricter rules for handling privacy coins.
Supporters of privacy coins argue that privacy is a basic human right, and these coins are vital for protecting user anonymity. However, to keep up with changing regulations, privacy coins may need to offer optional privacy settings instead of enforcing privacy by default. Working with regulators and showing legitimate use cases could help privacy coins stay relevant while addressing regulatory concerns.
Conclusion
Compared to traditional payment methods like credit cards, cryptocurrencies offer a special layer of security through blockchain technology. They use advanced public key cryptography to encrypt and decrypt transactions.
Privacy coins further ensure that your personal information remains private—no one can access your transaction details or trace them back to your real identity, including your IP address.
They ensure confidential transactions and provide a completely anonymous experience, unlike Bitcoin transactions, which can often be traced back to individuals.
Anonymous coins have faced scrutiny in the United States and beyond but continue to serve a real-world purpose. As noted in resources like Wikipedia, privacy coins offer a wide range of uses today.