What Are Privacy Coins in Crypto?

If you’ve seen Bitcoin mentioned in mainstream entertainment such as TV shows and movies, you might have gotten the impression that Bitcoin is a secretive technology used by nefarious hackers. Even though depictions of Bitcoin use often involve a hooded figure typing up a storm on their keyboard in a dark room, the truth is that Bitcoin is not very private at all. The same is true for Ethereum and most other cryptocurrencies with a large market capitalization.

However, there are cryptocurrencies that actually offer privacy to their users. Typically, they’re referred to simply as “privacy coins”. This loosely defined term refers to cryptocurrencies that implement technologies which make it difficult for people not involved in a transaction to see who was involved in the transaction and the amount of crypto that was sent.

Privacy coins explained

Privacy coins are a relatively small niche of the cryptocurrency market, even though they have been around for several years now. According to CoinCodex data, the combined market capitalization of all privacy coins on the market is about $3.8 billion, which is only about 0.34% of the total cryptocurrency market cap. 

At the moment, the 5 largest privacy coins by market include:

In order to better understand how privacy coins ensure privacy for their users, let’s quickly explore the two biggest privacy coins available on the market.

Monero

Monero (XMR) is by far the largest privacy coin, and accounts for roughly 70.5% of the privacy coin sector’s market capitalization at the time of writing. The open source Monero project was launched in April of 2014 and was created by an anonymous developer using the pseudonym Nicolas van Saberhagen.

On Monero, all transactions are private, which means that noone can see which wallet addresses were involved in any given transaction and how many XMR coins it involved. Monero achieves this through a variety of technologies, including RingCT, Stealth Addresses, Ring Signatures and more. 

Monero is designed for use as a simple peer-to-peer digital currency, and doesn’t have smart contracts functionality. Unlike Bitcoin, there is no maximum limit set on the XMR supply, as it implements a modest degree of inflation to ensure miners have sufficient incentives to continue securing the network. There is no Monero halving, and the reward for mining a Monero block is fixed at 0.6 XMR in perpetuity.

Another interesting aspect of Monero is that it implements an ASIC-resistant Proof-of-Work consensus algorithm. An ASIC is a chip that’s designed to perform a very specific task as efficiently as possible. Meanwhile, the central processing units available in desktop computers, smartphones and similar devices are designed for general-purpose use.

The mining of Bitcoin is dominated by ASICs because they are orders of magnitude more efficient at mining BTC than general-purpose computer hardware. This makes it difficult for regular people to participate in mining Bitcoin, as ASIC-powered mining hardware requires a significant upfront investment to purchase and operate effectively.

Meanwhile, Monero’s RandomX algorithm makes it difficult for ASICs to mine the cryptocurrency efficiently. In fact, the algorithm is most efficient when used with consumer-grade central processing units. The idea behind this is to decentralize the process of mining and allow as many users to participate as possible.

Zcash

Zcash (ZEC) is the most credible competitor to Monero in the privacy coin sector, although it is much smaller — at the time of writing, it has a relatively modest market cap of $454 million. 

Zcash was introduced to the market in 2016. Its biggest innovation is the utilization of zero-knowledge proofs, which is a cryptographic technique that allows one party to prove to another that a statement is true while not disclosing any information other than the statement’s validity. 

In the example of Zcash, zero-knowledge proofs allow the protocol to ensure that each transaction follows the protocol’s rules (i.e. no double-spending or counterfeiting) while keeping the transaction’s addresses and amounts hidden. 

Unlike what we see with Monero, where all transactions are confidential, Zcash users can choose between sending transparent or private transactions. In Zcash, there are two types of addresses. Transparent addresses start with a “t”, while private or “shielded” addresses start with a “z”.

In terms of tokenomics, Zcash is very similar to Bitcoin and also utilizes a Proof-of-Work consensus mechanism. Like BTC, it also has a maximum supply of 21 million coins, and implements a halving mechanism that halves the reward for mining a Zcash block approximately every four years.

However, the Zcash protocol will likely migrate to a Proof-of-Stake consensus mechanism in the coming years. Electric Coin Company, which is spearheading the development of the Zcash protocol, has expressed support for such a move and a transition to PoS also seems to be broadly popular in the Zcash community of users.

Crypto’s privacy problem

Cryptocurrencies like Bitcoin and Ethereum implement a public ledger of transactions, which allows anyone with an internet connection to see every single transaction that was ever made on the network. This includes the transaction’s sender and receiver, the type and amount of cryptocurrency that was sent, the time at which the transaction occurred and countless other details. 

If you’re interested in having a look at what’s happening on a blockchain such as Bitcoin or Ethereum, you can simply use a blockchain explorer to access all the available information about any given address or transaction.

The details of a Bitcoin transaction. Blockchain explorers are free tools that allow anyone to track all the activity on a blockchain. Image source: Blockchain.com 

While it is true that you don’t need to provide any personal information whatsoever to use a cryptocurrency like Bitcoin and Ethereum, it’s a mistake to assume that your cryptocurrency transactions are private just because the blockchain protocol itself doesn’t require you to link your real-world identity to your blockchain address.

For example, when you used fiat currency such as USD or EUR to buy cryptocurrency on an exchange, you likely had to provide your personal information. Once you withdraw your coins from the exchange, a link exists between your identity and your blockchain address, even though this information is not available publicly. 

An employee could leak the information or it could be stolen from the exchange by hackers. Also, the exchange might be required to provide this information to law enforcement agencies or other authorities if requested to do so. 

We should also mention that if you use your cryptocurrency wallet to purchase goods or services from a store, that creates another possibility for your financial privacy to be breached and for someone to connect your identity to your transaction history on the blockchain.

In addition, blockchain forensics companies such as Chainalysis have large databases and advanced algorithms that allow them to track blockchain transaction flows in great detail and establish links between different entities. 

The Reactor software created by Chainalysis provides detailed information about blockchain transaction flows.

Most cryptocurrencies do not offer true privacy, and you should be aware of that when making transactions involving the blockchain. Privacy coins attempt to address this issue by implementing technologies that make it difficult for outside observers to see the addresses and amounts involved in transactions.

Regulatory pressure on privacy coins

While privacy coins are a very powerful technology for anyone who wants financial privacy, they are unfortunately sometimes used to facilitate illicit activities. In recent years, regulators around the world have started cracking down on privacy coins. Depending on your perspective, this can be interpreted as an attempt to curb the criminal use of privacy coins or as a way to restrict the financial freedoms of the general population.

Privacy coins are quite a controversial topic, and many people who are interested in crypto wonder if privacy coins are legal. The answer to this question depends on your jurisdiction. In the United States, privacy coins are legal. For example, you can buy Monero on the Kraken exchange and you can buy Zcash on both Kraken and Coinbase.

However, other countries have imposed restrictions on privacy coins. In Australia and South Korea, for example, cryptocurrency exchanges are prohibited from listing privacy coins, but they are legal to own. In Japan, privacy coins are banned outright, and Dubai has also banned the issuance and all activity related to privacy coins.

Before choosing to buy or use privacy coins, we recommend that you check the regulations in the country you live in to avoid any issues. For now, privacy coins are allowed in most countries but regulators in many countries have been putting pressure on cryptocurrency exchanges in an attempt to dissuade them from listing privacy coins.

The bottom line

Privacy coins are a very powerful tool, as they allow users to send value to each other across the globe on a 24/7 basis while keeping their transaction activity completely confidential. However, privacy coins are under constant pressure from various regulatory bodies, which is perhaps why they only represent a very small part of the cryptocurrency market.

If you’re looking to explore the crypto markets beyond just privacy coins, make sure to check out our list of the best cryptocurrencies to buy now.

FAQs

Are privacy coins really private?

Yes, leading privacy coins such as Monero and Zcash are really private. These coins implement advanced privacy technologies to ensure that transactions cannot be traced.

What is an example of a privacy coin?

At the moment, the 5 largest privacy coins by market include:

What are the best privacy coins?

The best privacy coins on the market today are Monero and Zcash. Both of these cryptocurrencies provide very strong privacy protections and ensure that a transaction’s sender, receiver and amount are not disclosed to the public.