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How Anonymous is Cryptocurrency? Privacy Coins

19 Aug 2022 By : Abhinav Nagar
Southeast Asia’s Lar

Considering the rise in crypto hacks and thefts, security issues related to cryptocurrencies and blockchains are becoming quite prevalent. People use anonymity in blockchain to some level of concern for their security and privacy purposes. As they begin to understand blockchain security, they tend to become confused regarding anonymity and pseudonymity. 

There are many ongoing arguments about how important it is for users to maintain their anonymity and why cryptocurrencies should adhere to pseudonymity. Usage of privacy coins and crypto mixers for money laundering is also a major concern these days. In order to understand these ongoing activities, one must understand what these terms signify. Why are they so crucial for describing the blockchain's underlying technology? How do they affect blockchain security, then? Read this article till the end. It will clear all your doubts.

Understanding Anonymity and Pseudonymity

A few definitions first. The terms "anonymity" and "pseudonymity" describe two distinct strategies for hiding or obscuring one's identity. The terms have a deeper meaning in DeFi since users frequently preserve pseudonymity or anonymity to safeguard their identity and hide their transactions.

Anonymity:

Anonymity means that no one knows the person's real identity but surely knows about your online activity. In the context of blockchain security, anonymity implies that activity or transactions on the blockchain or exchanges can be linked to a specific user. It keeps your actions and your identity apart.

Pseudonymity:

Pseudonymity means that even when the identity of the person making transactions is unknown, all of the transactions they make can be linked to the same pseudonymous identity. Pseudonymity is used to keep your identity under a different name while hiding your true identity. In terms of blockchain security, it means that online activity can not be linked to the identity of a person, but it can be linked to the same pseudonym. 

What makes it essential for cryptocurrencies?

Anonymity and pseudonymity are considered some of the core tenets of cryptocurrencies. The idea of anonymity was one of the beliefs maintained by those who supported the development of these digital trade techniques when the Bitcoin network first appeared in January 2009. The most notable example is Satoshi Nakamoto, who is thought to be the creator of the Bitcoin network and, up until this point, has maintained his anonymity by using a pseudonym. 

Anonymity means that a user can possess a cryptographic address without disclosing any information about their identity. There would technically be nothing connecting such addresses or identifying the real identity of the owner, even if one individual held many addresses.

Pseudonymity in cryptocurrency means that a user's behaviour is connected to their wallet, which has the form of a lengthy cryptographic address, even though that user's identity is unknown. Additionally, as soon as an address is associated with you, any transactions conducted from and to that address can also be connected to your real-world identity.

In the majority of cases, blockchain technology is not really anonymous. It is pseudonymous instead. Without asking anybody or registering anywhere, you are, of course, free to make as many address-secret key pairings as you choose, and each address serves as a pseudonym for you.

The largest cryptocurrencies currently in circulation, are Bitcoin and Ethereum, and most of the altcoins run on pseudonymous systems. However, some cryptocurrencies like Zcash, Zerocoin, and Monero are fully anonymous.

These cryptocurrencies, which work on anonymous systems, are known as Privacy Coins. Let’s see them in detail.

Privacy Coins

Privacy coins are a type of cryptocurrency that is based on two basic principles: privacy protection and data security. Privacy coins use blockchain technology as a distributed ledger, much like other cryptocurrencies. Although most cryptocurrency transactions are made public, privacy coins are made in a way that makes it difficult to link transactions.

Private coins employ encryption to hide a user's wallet balance and address to retain a measure of privacy, which distinguishes them from ordinary crypto.Regular cryptocurrency coins aren't entirely private since blockchain transactions are visible to everyone and recorded on a public ledger. While such a system has many benefits, it does not completely protect users' privacy and anonymity, which makes it simpler to connect a person's identity to their address.

Three cryptographic methods that some privacy coins employ

Stealth addresses: To safeguard the recipient's anonymity, each transaction creates a unique address.

Zk-SNARKs: Zk-SNARKs, which stands for the zero-knowledge succinct non-interactive argument of knowledge, enables you to demonstrate the validity of a transaction without disclosing any specifics (sender, receiver, amount).

Ring Signatures: If you use a private key to sign a transaction, people may be able to connect your address to your signature. That is prevented via ring signatures.

Since many signatures are included in the transaction, it is more difficult for others to link your signature to your address.

Importantly, the design and structure of each privacy coin will determine this, as some are more traceable than others. Not every privacy coin is as secret as it claims. Poorly designed protocols could include weaknesses that allow for the tracking of their transactions.

Impacts of Anonymity and Pseudonymity

In the beginning, it was widely believed that cryptocurrencies like Bitcoin were a haven for criminals since they were completely anonymous and untraceable. But when businesses and the general public learned more about blockchain technology, it became clear that the public transaction record for Bitcoin was actually a rich source of data.

If some cryptocurrencies are completely anonymous, others are completely traceable and transparent due to their pseudonymity.

Because blockchain offers anonymity, many people have been able to avoid interference from hostile and military dictatorships. Because of anonymity, any actions that would make it simpler to confirm a user's real identity would be considered as obstructing and providing privacy to the user, which is one of the main goals of blockchain.

By hiding information, activists and other individuals can oppose oppressive regimes and dictatorships. Unfortunately, it also provides criminals with additional ways to smuggle illegal digital goods without being discovered.

Unfortunately, the anonymity offered by privacy coins has made it simpler to conduct criminal activities as the authorities are unable to track transactions of these coins. Since criminals' addresses are impossible to trace, thefts may increase as a result.

Hence, pseudonymity is used by most cryptocurrencies as it links customer data with crypto transaction histories and can stop anti-money laundering (AML) and other criminal conduct in its tracks.

Bottom Line

As the industry of cryptocurrencies and blockchain technology expands and becomes an increasingly essential aspect of our knowledge of Web 3.0 and the Metaverse, we can see how the nature and purpose of pseudonymity and anonymity are likely to become a key issue of contention between the sector's expansion and government and institutional regulation.

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