Will privacy coins be best handled to please both law enforcement and those who want the greater anonymity they provide?
On New Year’s Day, the U.S.-based crypto exchange Bittrex revealed via Twitter that it will withdraw three big privacy coins: Monero (XMR), Zcash (ZEC) and Dash. The relation offered more information, but those who followed it heard little to explain why trading in those tokens would stop on Jan. 15.
Yet, the news couldn’t have been so unexpected. This days, regulators, both in the United States and overseas, have looked at privacy coins. Unlike Bitcoin (BTC) and Ether (ETH), coins offer improved anonymity by covering user addresses and transaction amounts that make transactions more challenging to monitor. Security authorities suspect that they could be used for tax avoidance, money laundering and potentially other illegal activity.
The U.S. Treasury Department’s Financial Fraud Compliance Network, for example, acknowledged in its Dec. 23 draught rule reform that anonymity-enhanced cryptocurrencies, or AECs, “have a well-documented connection to illicit activity” having been “used to launder bitcoins paid for the wallet used in the Wannacry ransomware attack,” for example. In addition:
“Several types of AEC (e.g., Monero, Zcash, Dash, Komodo, and Beam) are increasing in popularity and employ various technologies that inhibit investigators’ ability both to identify transaction activity using blockchain data and to attribute this activity to illicit activity conducted by natural persons.”
The U.S., abroad. Internal Revenue Service reported in September that it would offer a bonus of up to $625,000 to someone who might crack Monero, the most commonly used privacy coin—suggesting that the department assumes that the coin can be used to hide taxable profits.
“Bittrex’s action does not surprise me”
Timothy Massad, former president of the U.S. Commodity Futures Trading Commission and now a senior fellow at Harvard University’s Kennedy School, Cointelegraph said, “Bittrex’s action doesn’t surprise me.” He went on to make it clear that “the use of crypto for illegal purposes has been a major concern of law enforcement agencies and regulators in the U.S. (and elsewhere) so the focus on privacy coins is to be expected.”
The scrutiny of the coins is not confined to the United States. In 2019, the South Korean unit of OKEx delisted five privacy coins, including XMR, Dash and ZEC, citing the G20’s Financial Action Task Force’s Anti-Money Laundering rules — in particular, the need for the exchange to have an address for both the sender and recipient of a crypto transaction, which privacy coins do not provide. Japan, for its part, banned privacy coins in June 2018, referring to Monero, Zcash and Dash at that time as “three anonymous siblings.”
BTC remains “currency of choice for criminals”
But as is often the case with cryptocurrencies, things aren’t as simple as they first appear. While acknowledging that many of regulators’ concerns with privacy coins are valid, Jevans observed that “the data still shows that Bitcoin, which is more traceable than cash, remains the currency of choice for criminals because of the ubiquity of off-ramps into fiat.” Meanwhile, following the Bittrex delisting, Dash’s Twitter account unsurprisingly issued a defensive statement, noting: “Dash’s privacy functionality is no greater than Bitcoin’s, making the label of ‘privacy coin’ a misnomer for Dash.”
Others indicated that the Bittrex move may have been an attempt to conform with the FATF Anti-Money Laundering Rules or the “Travel Rule” and, if so, other U.S. exchanges which quickly do the same. Andrew Miller, a professor at the University of Illinois and a board member at the Zcash Foundation, had reservations about this theory, saying to Cointelegraph: “Since Kraken, Gemini and other exchanges continue to list private coins, I don’t think it’s because of a specific regulatory requirement.”
A spokesperson for the Bittrex said: “Bittrex does not have a comment for this story.” accourding to our source. It should be noted that Bittrex U.S. also delisted XRP on Dec. 29, but that is likely down to the U.S. SEC filing charges against Ripple.
“Nothing inherently wrong”
There is nothing intrinsically troubling about privacy coins, other critics contend. They are, indeed, a valuable invention, but maybe they ought to be properly handled. “Privacy coins are not inherently wrong with anything,” Jevans said, even though they make it easier than BTC to launder money.
Cash is easier to launder than Bitcoin, as noted, but nobody is dreaming about cash removal, he suggested. “Miller added that privacy coins could also be a counter-agent for authorities to excessively monitor crypto markets, including “warrantless bulk surveillance.
“A professor at Carnegie Mellon University, Giulia Fanti, said: “The global economy is heading towards a digital financial infrastructure that will enable government and/or corporate fine-grained surveillance.” Among other factors, privacy coins matter, as they mean innovation:
“They are helping spur the development of cutting-edge privacy technologies that could eventually be used in centralized digital financial services. So, while privacy coins can certainly be used for money laundering, they also provide an important counterweight to some concerning societal trends.”
Preston Byrne, a partner of Anderson Kill law firm, tsaid: “Privacy coins are an important innovation not only in terms of promoting the development of new decentralised crypto systems, but also in terms of the importance to society of generally having a confidential means of entering transactions, a role currently filled with cash.” In comparison, privacy coins could be less effective in hiding cer coins.
“Attempting to hide one’s activity through a privacy coin is also unwise due to the fact that, at least for the time being, getting from the cryptoverse into real assets requires touchpoints with regulated exchanges where KYC [Know Your Customer verification] is conducted. Pushing privacy coins off of exchanges where KYC takes place strikes me as counterproductive.”
Importance of “regulated touchpoints”
Still, Jevans believes that “we should expect more exchanges in the U.S. and globally to delist privacy coins in order to ensure compliance until they can deploy a risk-based approach to preventing money laundering.” This may not help, though, said Byrne: “In the long term, the explosive growth in so-called ‘decentralized exchanges’ will likely pick up the slack, without the benefit to the government of having coins occasionally make contact with regulated touchpoints.”
These “regulated touchpoints” could indeed prove privacy coins’ salvation. A custodial wallet operator, for instance, “can generally see the transactions a user is executing and can still require the user to provide some form of identity,” explained Fanti, adding:
“So, even if a privacy coin hides transaction contents on the public blockchain, there may still be ways to enforce regulatory requirements — at least for some important classes of transactions — with the cooperation of custodial wallet operators.”
“Both Zcash and Monero also support a “view keys” technology that provides an option to securely disclose information about a transaction to auditors or regulators, as Miller added: “It is a widespread misunderstanding that privacy coins fundamentally compromise or are incompatible with the existing way regulations are implemented.
It was revealed on Jan. 7 that a crypto custodian would issue wrapped Monero on the Ethereum network, indicating that not only DEXs will work to find a location for the flourishing of the three so-called privacy coins.
Expect more KYC/AML enforcement
Ultimately, on the part of regulators and the crypto community, a kind of balancing act will be needed, where the task is to protect the privacy capabilities of cryptocurrencies but without making them a refuge for money launderers and criminals of ransomware.
“I would expect to see continued efforts to address the risk and to step up KYC/AML enforcement as the new administration comes in,” Massad told Cointelegraph, adding: “Whether privacy coins can be ‘managed better’ to satisfy both law enforcement interests and those who like the greater anonymity they provide is an interesting question. I can’t say I’ve seen that yet though.”
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