Private practice, privacy coins allow crypto trading in the dark
By Paul Golden
Updated
Private markets may be outstripping their peers in the traditional finance sector but the reverse is true of crypto.
While digital bellwether BTC has a market capitalization of nearly $600m, according to CoinMarketCap.com, market leading privacy coin Monero (XMR) is worth roughly $3.5bn.
Volatility in the two largest privacy coins shows no sign of easing with Monero fluctuating between $164.16 and $179.01 on 20 May alone while Zcash (ZEK) traded from a low of $101.36 to a high of $110.82 according to Coinbase data.
Recent weakness has been exacerbated by the Terra depeg, even though the issues in this instance were very idiosyncratic.
Bitcoin to US dollar (BTC/USD)
“In times of turmoil, there is a market saying that ‘correlations go to one’,” says Ryan Shea, crypto economist at trading platform Trakx.
What this means in practice is that privacy coins have been trading in lock-step with other cryptocurrencies.
When asked to explain why investors continue to express interest in privacy coins, Haven Protocol developer ‘Harlequin’ refers to factors as diverse as Canadian truckers having their bank accounts frozen and the weaponization of the SWIFT payment system against Russia.
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Why do people use privacy coins?
“Many people are worried that they might be next, which has opened their eyes to the need for financial privacy in order to protect their money and ability to transact,” he says.
Chain analytics makes it very easy to determine the wealth of individuals owning public cryptocurrencies (or surveillance coins as they are referred to in the privacy coin world) has pushed a lot of people into private cryptocurrencies such as Monero and Zcash.
Monero to US dollar (XMR/USD)
Monero community member Ian Niculescu, who says there was a clear link between US President Joe Biden’s announcement of his intention to tax unrealised capital gains in late March and increased trading in privacy coins.
“Another factor may be the ‘Monerun’ that took place on the coin’s eighth birthday,” he says.
“Some members of the community were sceptical about the fact that exchanges were holding full reserves and decided to urge everyone to withdraw their Monero. A lot of exchanges suspended withdrawals and that day the price of Monero spiked.”
It is important to note that not all privacy coins are structured the same way, so potential investors need to understand the fundamentals behind the token.
Monero is cryptographically private by default in contrast with better known digital coins such as ETH or BTC.
Ethereum to US dollar (ETH/USD)
Unlike Zcash, the second largest privacy coin which has functionality that enables users to disclose transaction data if they wish, Monero’s privacy features cannot be turned on and off by the user.
Monero and Haven Protocol also use a view key that allows the user full control over who they give access to.
According to Harlequin, opt-in privacy is largely ineffective as it gives exchanges and other third parties the ability to discriminate between shielded and open transactions.
Making use of stealth addresses
Monero uses stealth addresses, which are randomly created addresses for each transaction. Combined with output masking ring signatures, which group transactions together to avoid traceability, the risk of blacklisting is removed.
In contrast, Zcash uses zero-knowledge proofs to ensure privacy. This technology allows users to confirm that they have the correct information without having to disclose the information.
Zcash to US dollar (ZEC/USD)
Another key difference is the structure of the organisation behind the two coins, says Shea.
“Monero is a decentralized community project whose leadership team largely operates under aliases whereas Zcash is more transparent about its leadership structure and has considerable academic backing.”
While there are privacy coins like Secret (SCRT) that typically shield data inputted into smart contracts, others are focused on facilitating anonymous transactions, says Adam O’Neill, CMO of exchange Bitrue.
Secret to US dollar (SCRT/USD)
O’Neill recommends backing privacy tokens whose fundamentals are broader than just transaction shielding “as regulators are typically onto these kinds of coins.”
Privacy coins that allow users to conduct transactions without giving ID are not popular with governments because of their potential to be used to facilitate illegal transactions. Even though Shea suggests this is relatively uncommon.
“As a result, many major crypto exchanges do not list privacy coins because they need to comply with regulations,” he adds.
Off-ramp problems
“This is important for those providing on-off ramp capabilities (conversion from crypto to fiat) because they require access to the traditional financial sector.”
The threat of exclusion is what gives the regulators the necessary leverage to ensure their rules are complied with.
The end result is that converting privacy coins into fiat currency is more of a challenge because there are fewer trading platforms where such transactions can be made.
The technology is rapidly developing and becoming more user friendly, but there can be a few additional hoops to jump through for those looking to convert privacy coins into fiat currency, acknowledges Harlequin.
“Projects such as THORChain (RUNE) are building cross-chain swaps and will be including privacy coins to allow greater flexibility in their use,” he adds. “Other platforms are also making progress in terms of making swaps easier to manage.”
THORChain to US dollar (RUNE/USD)
The most common solution is to use a centralised exchange, go through KYC, deposit your crypto and cash out, says Niculescu. “Another method can be to sell it person-to-person using the LocalMonero exchange,” he adds.
On this exchange, sellers can specify how they want to be paid – for example in cash, via bank transfer, or through an online payment processor such as PayPal.
Users who create advertisements are charged a 1% arbitration protection fee for every completed trade.
PayPal Holdings (PYPL)
Evan Cohen, co-founder and COO of investment search engine Vincent highlights risk and lack of ease as drawbacks to privacy coin investment.
He says that when not using an exchange, improper transactions are very possible and can lead to losses and that depending on the soundness of the investor’s security knowledge and setup they may be more prone to hacks.
He adds that less experienced crypto investors may struggle when not using exchanges and that even long time users may not want to spend the time and effort.
“If you want the simplicity of a centralised exchange but yours doesn’t list Monero, you can always use a decentralized exchange to convert your monero to bitcoin or tether and cash out with Coinbase,” says Niculescu.
“Majestic bank, ChangeNow, and TradeOgre are examples of such exchanges and projects like Haveno and Penumbra are making KYC-free off ramps easier.”
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