Privacy Cryptocurrencies

-- By RaulMazzarella; Final version

Privacy in the online financial system

The right to privacy has been recognized as a human right in several constitutions and statutes around the world, among other reasons, because of its importance as a form of respect to the individual and its relation with freedom of speech. The protection of the right to privacy within the internet is of the greatest importance, especially after the famous Snowden’s global surveillance disclosures. In this context, privacy cryptocurrencies appear as an alternative to protect this right specifically within the online financial sector but with several problems to be addressed on the way to this goal.

Nowadays, a considerable amount of financial transactions is made in a digital fashion and everything indicates that this trend will keep growing. Usually, these kinds of transactions have to be made through the banks' centralized systems, so it is almost impossible to escape from them if you want to perform an online operation. Of course, cash is always an alternative, but it is not convenient to travel with a big bag filled with cash, especially if the transaction is international. Moreover, Some central banks are evaluating the idea of issuing a digital currency fully controlled by the relevant government or bank, eliminating cash altogether. This idea would have benefits for the users, such as fast and secure transactions and States would have easier control of money laundering, bribery and terrorism financing. However, this financial system comes paying a great price: privacy for the users of the system, and here is exactly where this technology enters the game.

The alternatives

In general, cryptocurrencies are an internet-based medium of exchange which uses cryptographical functions to provide financial transactions. These new kinds of currencies, most of the time, use blockchain technology and proof of work mechanisms to gain decentralization, transparency, and immutability.

Non-fully private cryptocurrencies, such as Bitcoin, are pseudo-anonymous (no individual person can be linked with a specific wallet or transaction per se). However, most of the time, they have public blockchains, which are public ledgers where the information about wallets and transactions is stored. With this information, it is possible to link transactions to real identities.

To the contrary, privacy cryptocurrencies use the same blockchain technology, but try to go one step further, concealing information about senders and receivers during transactions through a variety of technical methods. The most famous of these coins are Monero, Zcash and Verge.

The issues

Due to its intrinsic characteristics, private cryptocurrencies have been subject to controversies for their relation to ransomware attacks, hacks, money laundering, bribery and terrorism financing. For these reasons, some cryptocurrency exchanges are delisting this type of coins and even some countries like Japan and France are banning these kinds of crypto assets entirely.

However, if we compare the amount of money that the world’s wealthy obscure using traditional vehicles that make it difficult, if not impossible, to identify the true owners of wealth, this new technology appears to be only a child’s game. Some even state that the traditional “dark wealth” hides many of the richest people in the world. Additionally, we have to take into account that some researchers have calculated that the U.S. Dollar is used 800 times more than Bitcoin in money laundering activities, which reminds us that it is extremely difficult to have complete control over financial activities in general. Additionally, we cannot forget that criminals use every new technology in their favor. Shockingly, criminals use cars, mobile phones and the internet itself. Finance and tax law can deal with other similar schemes of collectibles of inherently limited quantity in the world financial system and private cryptocurrencies are not more dangerous nor obscure than these schemes.

Regarding the regulation, I believe that a ban on this kind of asset is not necessary. If we look at the Ethanol Tax Credit and its administration system you can question yourself why private and non-private cryptocurrencies couldn’t be regulated in some similar manner regarding tax and financial matters. The Ethanol Tax Credit was born to subsidize farmers to grow corn and convert it eventually to ethanol and gasoline. This was attested by a nineteen digit number that identifies each gallon of ethanol subject to tax credit so, this was really similar to a cryptocurrency based in an income source in the American tax law in which at least, in theory, the token represents a physical object with a price, just like in an Initial Coin Offering or ICO of a new cryptocurrency. The difference is that it did not use blockchain technology and was authenticated by the government itself. Investment companies used this scheme to surreptitiously invest in commodities, which they could not do directly.

For this reason, my view is that this kind of assets should be regulated in a similar fashion than the aforementioned other collectibles and regulatory schemes that are analytically closely-related but using an additional control within the cryptocurrency exchanges, specifically at the moment of its conversion to a traceable cryptocurrency or fiat (regular) money. The users of these assets should justify a general reason for its use just to discard the abovementioned risks as much as possible, following the anti-money laundering/combating the financing of terrorism (AML/CFT) standards and regulations. Of course, this will limit the privacy that these crypto-assets intend to have, but I believe this is the only reasonable way to keep them under control.

Conclusion

This paper discussed privacy concerns in the financial system. There are people that have begun to apply solutions to these concerns within the boundaries of the technology that we have today, but with severe issues on the way to achieve this.

As a matter of public policy, governments should implement the strictest privacy laws to ensure that the “standard” online financial system protects this important right. In the way to accomplish this, the academy and the general population should help letting the governments know of their interest in this human right. On the same note, the transaction obscuring within the traditional system for illicit purposes should be discouraged.

Regarding privacy cryptocurrencies, they are an interesting experiment to try to solve the privacy problem within the financial system and they should be regulated similarly as other collectibles and regulatory schemes of similar nature (such as the Ethanol Tax Credit) adding further controls within the context of the cryptocurrency exchanges, applying to them AML/CFT policies, but trying to preserve the privacy of the users as much as reasonably possible, to avoid the risks associated with them.

I believe that it is impossible and dangerous to achieve complete privacy within the online financial system for the reasons stated, but we, as a society, should do everything at our disposal to reasonably protect the privacy of the users of the same in the traditional financial system and in the cryptocurrency world.