What Are Privacy Coins? Can They Thrive After the Tornado Cash Ban?

What Are Privacy Coins?

As the term suggests, privacy coins operate in such a way as to provide users with a certain level of anonymity. The means by which they achieve this varies according to the privacy coin under consideration, with the following being a summary of the biggest cryptocurrencies in the category:

• Monero (XMR) – has a market cap of roughly $2.5 billion as of writing. With Monero, the sender, receiver and value of every single transaction are hidden through its use of three key technologies: Stealth Addresses, Ring Signatures and RingCT. Stealth addresses create one-time addresses that are disposed of following usage, ring signatures allow for transactions to be batched in groups, while RingCT hides the quantity of funds transacted. Monero also uses a number of other privacy-enhancing features, such as sending transactions over the Tor network, as well as using Danelion++, which makes it harder to connect transactions.

• Zcash (ZEC) – has a market cap of $700 million. Enables anonymity through shielded addresses, which like Monero hide the sender, receiver and transaction amount. These operate using zero-knowledge proofs, a means of verifying transactions without revealing private keys. Zcash also enables users to send encrypted messages via transactions, and it offers the option of having transparent transactions, in addition to shielded ones.

• Decred (DCR) – has a market cap of $370 million. Decred is a proof-of-stake cryptocurrency that offers CoinShuffle++ as an optional feature, enabling users to mix transactions. With CoinShuffle++, output addresses are bundled together, making it harder to connect transactions and accounts. This mixing service is hosted on a centralized server.

• Horizon (ZEN) – has a market cap of $175 million. A cross-chain platform for developing blockchain networks, Horizon lets developers implement zero-knowledge proofs, which are used as a means of hiding private keys and the associated addresses.

• Secret (SCRT) – has a market cap of $166 million. Secret distinguishes itself from most privacy coins/blockchains by offering private smart contracts, meaning that inputs, outputs and the state of contracts are encrypted and inaccessible to third parties. This arguably makes Secret more useful as a blockchain platform in contexts where confidentiality is paramount (e.g. healthcare).

These are the five biggest and most prominent privacy coins in the cryptocurrency market right now, although CoinGecko currently lists 79 in total, making it a relatively niche sub-sector of the industry. Indeed, aside from Monero, every privacy coin in the market has a market cap of less than $1 billion, indicating that demand for such coins is comparatively small. This view is supported by the fact that, on CoinGecko, privacy coins are the 35th biggest cryptocurrency category by total market cap.

The Tornado Cash Ban and the Regulatory Future of Privacy Coins

Part of the reason why the market for privacy coins is so small (despite having an actual use case) is that a number of major crypto-exchanges have either refused to list such coins, or have delisted them in recent months.

For instance, Coinbase doesn’t support Monero, something which significantly reduces its potential market (although the exchange does list Zcash). The same goes for Binance.US, Kraken (in the UK), Gemini, Crypto.com, FTX.US and eToro, all of which do not list Monero, as well as most other privacy coins (with the occasional exception of Zcash).

This is a big problem for privacy coins, with the situation looking as though it may worsen. This possibility was highlighted starkly when Huobi — the eighth-biggest crypto-exchange by volume — delisted seven privacy coins (including Monero, Zcash Decred, and Dash), removing all of them as a tradeable option from September 19.

Announcing this move, the exchange made the following statement, which doesn’t exactly bode well for the future of privacy coins.

“Huobi Global strictly complies with the compliance policies of every country and region and always endeavors to safeguard our users’ assets. In compliance with the latest financial regulations and in accordance with Article 17(16) of the Huobi Global Token Management Rules, Huobi Global has terminated the trading service of the following privacy tokens.”

Looking at the current regulatory picture, it’s clear that most governments take a dim view of privacy coins, with many charging them with facilitating money laundering. This was made clear in the Department of the US Treasury’s statement on its sanctions against the “notorious” Tornado Cash service, which it claimed “launders the proceeds of cybercrimes, including those committed against victims in the United States.”

It’s not the first time the US Treasury has sanctioned a mixing service, with the department also banning the Blender service in May. And elsewhere in the world, it seems that other governmental authorities are gearing up to regulate privacy coins in similar ways, with the European Union passing strict traceability rules on crypto transactions in March that would put such coins in a very, very difficult position.

Together with the fact that many parts of the world (particularly in Asia) have already clamped down on privacy coins, this suggests that the likes of Monero will likely have a very limited future.

Still, this didn’t stop many privacy coins (e.g. Decred, Ergo and Secret) from enjoying above-average rises as privacy-seekers moved over to them from Tornado Cash, according to research published by VanEck in September. What this suggests is that, even with prohibition in many parts of the world, anonymity will remain in demand for years to come, potentially giving privacy coins a real raison d’être.