Privacy Coins: About Problems With Centralized Exchanges & Regulators
I am presenting a picture of the regulatory wave that privacy coins (might) face, the reasons behind it, and how decentralized technological solutions can help to maintain your privacy.
When it comes to cryptocurrencies, the word ‘regulations’ is not that far away. Since Bitcoin was born and stepped up to be a strong asset, attracting investors globally, including banks, big public companies, and even nation states, the demand for regulations grew further and further.
For one segment of cryptocurrencies, even while being in its very early stage, namely ‘privacy coins’, this is a very hot topic in particular. Privacy coins make it possible to obfuscate transactions and hide important data such as sender and receiver wallet, as well as the amount of coins transferred.
In the eyes of three letter agencies, governments and regulators, they are a threat for multiple reasons; including difficulties to comply with KYC- and AML-regulations.
The biggest concern of privacy coin enthusiasts and investors is that privacy coins might get ‘banned’.
In this article, I am presenting a picture of the regulatory wave that privacy coins (might) face, the reasons behind it, and how decentralized technological solutions, such as the Navcoin PriFi ecosystem I am working for, can help avoid certain problems.
How Privacy Coins Work & Why They Are Needed
Without getting too technical at this point, privacy coins basically work like regular cryptocurrencies such as Bitcoin. They all run on decentralized ledgers, the blockchain, and are maintained by a group of validators. Some are using a Proof-of-Work (PoW) consensus, others a Proof-of-Stake (PoS).
That said, they all share more or less the same features, while the underlying technology might slightly differ: Concealment of the sending and receiving addresses, as well as the amount of coins being sent.
This way, privacy coins are solving one of Bitcoin and Ethereum’s biggest problems, which is the fact that they are not anonymous but pseudonymous: Every transaction can be traced back to its origin, making anonymity impossible.
Yet, there are ways to ‘anonymize’ your pseudonymous Bitcoin. One of the methods to do so is using a ‘Bitcoin Mixer’, often called ‘tumblr’. Here, Bitcoin transactions are gathered in private pools and shuffled before getting redistributed to the intended receivers. Different options cover centralized as well as decentralized solutions.
While this is technically a legit approach, those mixing services are not without weaknesses. One of the biggest problems is that one can check if somebody mixed Bitcoin. If identified, exchanges might have an issue with it, freezing the coins directly after deposit or when trying to withdraw. The world's biggest cryptocurrency exchange Binance, for example, is already blocking withdrawals to Wasabi.
Law Enforcement Hunts Down Bitcoin Mixer Operators
Law enforcement worldwide is hunting down the creators of said Bitcoin mixers, resulting in shutdowns and arrests. In August 2021, an Ohio resident from the USA pleaded guilty to operating a darknet-based Bitcoin mixer that laundered over $300 million.
More recently, the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) sanctioned the Bitcoin mixer Blender.io, blacklisting addresses. This was a hot topic because it was directly connected to one of the biggest hacks, executed by the North Korean hacker-group ‘Lazarus’.
We see one thing very clearly: Regulators really do not like the idea of citizens being able to act in private. While the reasons seem noble at first (preventing money laundering, movement of illicit funds, etc.), we should dig a bit more into regulators' takes and their motives.
Especially when it comes to privacy coins, which will make it a lot harder for them to enforce their regulation attempts.
Origins Of The Criticism Regarding Privacy Coins
At its core, the criticism towards privacy coins is based on some ‘myths’, which are:
Privacy coins are used for money laundering
Privacy coins are used for tax evasion
Privacy coins are used for financing terrorism
While there is a kernel of truth in every one of those points, the main point is usually missing in public conversations about this topic:
The fact that FIAT money, the US-Dollar in particular, is still the #1 when it comes to money laundering, tax evasion, and yes, even the financing of terrorism. Let’s take a look at related news from the TradFi sector from the last years:
On February 7, 2022, news came out that revealed that Credit Suisse, one of the biggest Swiss banks, was facing money laundering charges in a Bulgarian cocaine trafficker’s trial. They allowed ‘an alleged Bulgarian cocaine trafficking gang to launder millions of euros, some of it stuffed into suitcases.’ Prosecutors were seeking around $45 million in compensation - Source Reuters
A bit earlier, on December 17, 2021, HSBC got fined more than $70 million for anti-money laundering failings. ‘The Financial Conduct Authority (FCA) said weaknesses in HSBC's financial crime safeguards had been highlighted several times before action was taken.’ - Source BBC
When you think about those magnitudes and then take a look at the trading/exchange volumes of privacy coins like XMR (Monero), it becomes very clear that this must be about more than just ‘protecting citizens’.
Also, it is worth looking for data regarding the illicit share of all cryptocurrency transactions by year, based on data from the blockchain analysis company Chainalysis from the year 2022:
It shows not just that even the spike in 2019 accounted for just 3.37% of all illicit transactions but also the hard drop in the last two years, bringing the level down to 0.15% in 2021. Moreover, the spike in 2019 can be explained. This was the year of one of the biggest scams ever in our industry, namely PlusToken. People lost billions of USD in this pyramid scheme; and transactions in this regard were categorized as ‘illicit’.
Last, but not least: Do not forget that this study is about ALL cryptocurrency transactions and not just privacy coins. If we take this into account the share will be far below 0.1%.
Regulators’ Takes: Japan, South Korea, Australia, UK Are Anti Privacy
The first country whose financial watchdog ‘banned’ privacy coins was South Korea. In an announcement published on November 3, 2020 the FSC, Financial Services Commission of South Korea, stated that the country would not allow any digital asset that might be used for money laundering. In particular they were talking about ‘dark coins’, without mentioning particular ones.
In addition to South Korea, Japan, Australia, and the United Kingdom have imposed similar regulations. In most parts of Europe, as well as the USA, privacy coins are still legal but will be subject to more and more regulation. On the side, there are some organizations who are following a different approach.
Instead of working on regulations and bans, orgs like the IRS have dedicated a bounty ($625,000) for the person who is able to crack the privacy-mechanism of XMR (Monero).
Centralized Exchanges Banning Privacy Coins
Those regulatory ambitions pose another problem for the privacy coin sector, which are ‘foresighted’ cryptocurrency exchanges who might think banning those coins from their exchanges might help them prevent regulatory turmoil in the near future.
So it was not that surprising when a lot of exchanges delisted coins like XMR in 2021. For example, the exchange Kraken banned XMR trading for UK customers, other exchanges like Bittrex banned trading for coins like XMR, ZEC and DASH.
Unfortunately, Navcoin also got hit recently and will be delisted from the Binance exchange, which leads us to the necessary focus on decentralized exchanges.
CEX vs. DEX - The Future is Decentralized
So far, the imposition of exchange bans is the only effective weapon in the arsenal of regulators. When you think about it, there is not much more they could do. As long as a privacy coin network is truly decentralized, with no central entity behind it and running it, the only way to limit their usage is to ban them from centralized exchanges.
More fundamental bans are lacking two things. First, the legal grounds, as privacy coins are a new technology and can hardly be applied to existing laws, as well as the enforcement of a general ban of private cryptocurrencies.
‘Is it all over then?’ you might now ask yourself. The answer is a clear ‘No!’. The cryptocurrency sector is indeed an innovative one. For example, there were no ‘decentralized exchanges’ like we have today, just a few years ago. They don’t have a CEO, they are not owned by a central entity, and what is much more important - nobody can ban them or restrict the trading of certain crypto-assets. Nobody has control over your funds but you.
Labelled ‘DeFi’ (Decentralized Finance), this sector has grown a lot over the last years. In recent weeks, the TVL (Total Value Locked) had to suffer once again, but still, the trend could not be more clear:
We are sure that this trend will continue, which is the reason that we are working closely together with like minded projects, such as AtomicDEX, a decentralized exchange that can operate cross-chain. If you want to check it out, you can either visit their website or check out our intro thread on Twitter.
We at Navcoin believe that privacy is a fundamental human right as it is tightly knotted with other basic freedom rights. We live in a world in which we have to fight for those; nothing in this regard should ever be taken for granted.
Whoever wants to live in freedom has to fight for it!
The future is decentralized!