Blockchain privacy is not a binary choice; innovative technology can balance security and personal rights.

Authors: David Sverdlov & Aiden Slavin

Translation by: Deep Tide TechFlow

The emergence of new technologies—from telegraphs and telephones to the internet—has always been accompanied by anxiety over the impending demise of privacy. Blockchain technology is no exception, and discussions about blockchain privacy often contain misunderstandings: either it is believed to bring excessive transparency that threatens personal privacy, or it is seen as a breeding ground for crime.

However, the real challenge is not choosing between privacy and security, but rather how to build tools that support both privacy and security—on both technical and legal fronts. From zero-knowledge proof systems to advanced encryption technologies, privacy protection solutions are gradually expanding. Blockchain privacy extends far beyond the financial sector; it opens doors for applications in identity verification, gaming, artificial intelligence, and many other fields, truly benefiting users.

With the official signing of stablecoin legislation in the United States, the demand for blockchain privacy has become more urgent than ever. Stablecoins have brought an opportunity for a billion people to enter the cryptocurrency space. However, for users to be willing to use cryptocurrency for everyday purchases—from coffee to medical bills—they must be assured that their on-chain activities are private. Now is not the time for misunderstandings, but rather a time to take action and build solutions.

The debate over privacy has a long history, and its answers are not new: by insisting on innovation and rejecting misunderstandings, we can shape the future of privacy.

Misunderstanding 1: The Internet is the root cause of the modern "privacy problem"

Truth: Long before the internet emerged nearly a century ago, the communication revolution of the late 19th century propelled the development of privacy rights in the United States. Entrepreneurs developed many technologies that could transmit information in unprecedented ways, including the first commercial telegraph, telephone, commercial typewriter, microphone, and other media. The advent of these technologies dramatically changed the way information was disseminated. Historian and professor Sarah Igo points out that the privacy conflicts in America developed alongside new forms of communication, raising many new privacy issues: Could the media use someone else's name, likeness, or photograph for commercial purposes? Could law enforcement wiretap phone lines to listen in on conversations, or use photography and fingerprint technology to create permanent records or criminal identification registries?

Shortly after these technologies emerged, legal scholars began to address the privacy challenges they posed. In 1890, future U.S. Supreme Court Justice Louis D. Brandeis and lawyer Samuel D. Warren published “The Right to Privacy” in the Harvard Law Review. Subsequently, privacy law gradually developed through legislation, tort law, and constitutional law throughout the 20th century. However, more than a century after Brandeis and Warren's article, the first widely available commercial internet browser, Mosaic, was launched in 1993, leading to a surge in internet-related privacy issues.

Misunderstanding 2: The Internet can function normally without privacy

Truth: The early lack of privacy protection on the internet severely hindered its broader adoption. Overall, before the internet emerged, people enjoyed a higher degree of privacy. As Simon Singh noted in “The Code Book”, early cryptography pioneer Whitfield Diffie pointed out that at the time of the Bill of Rights' passage, “any two people could have an absolutely private conversation by walking a few meters away from the road and confirming that no one was hiding in the bushes—this is a level of privacy that no one in today's world can enjoy.” Similarly, people could conduct financial transactions using goods or cash, enjoying the privacy and anonymity that are largely absent in most digital transactions today.

Advancements in cryptography have alleviated concerns about privacy, giving rise to new technologies that facilitate the secure exchange of confidential digital information and ensure data protection. Cryptographers like Diffie predicted that many users would demand basic privacy protection for digital activities, prompting them to seek new solutions that could provide such protection—namely, asymmetric public key encryption technology. The new encryption tools developed by Diffie and other researchers have become the foundation of e-commerce and data protection. These tools have also paved the way for the exchange of other confidential digital information, which is now applied in the blockchain space.

The development of HyperText Transfer Protocol Secure (HTTPS) is a prime example, serving as a privacy tool that has driven the prosperity of the internet. In the early days of the internet, users (i.e., clients) communicated with web servers via HyperText Transfer Protocol (HTTP). This protocol allowed data to be transmitted to web servers but had a significant flaw: there was no encryption during data transmission. Malicious actors could thus read any sensitive information users submitted to websites. A few years later, Netscape developed the HTTPS protocol for its browser, adding a layer of encryption protection to safeguard the transmission of sensitive information. As a result, users could securely send credit card information over the internet and engage in private communications more broadly.

With encryption tools like HTTPS, internet users have become more willing to provide personal identification information, such as names, birth dates, addresses, and social security numbers, through online portals. This increase in security has made digital payments the most commonly used payment method in the United States today. At the same time, businesses have accepted the risks associated with receiving and protecting such information.

These changes in behavior and processes have spawned many new applications, from instant messaging to online banking to e-commerce. Today, internet activities have become an essential part of the modern economy, bringing unprecedented communication, entertainment, social networking, and other experiences.

Misunderstanding 3: Public blockchain transactions are anonymous

Truth: Public blockchain transactions are transparently recorded on a publicly shared digital ledger, making them “pseudonymous” rather than truly anonymous. This distinction is crucial. The practice of pseudonymity dates back centuries and played an important role in early American history: Benjamin Franklin published early works in the New-England Courant under the pen name “Silence Dogood,” while Alexander Hamilton, John Jay, and James Madison used “Publius” as the byline for The Federalist Papers (Hamilton used multiple pen names in his writings).

Blockchain users conduct transactions through wallet addresses, which consist of unique alphanumeric characters (i.e., keys) generated by a series of algorithms, rather than directly using real names or identity information. Understanding the difference between pseudonymity and anonymity is essential for recognizing the transparent nature of blockchain: while the alphanumeric characters of a wallet address cannot be immediately associated with a specific user's identity, the level of privacy protection for key holders is far lower than people imagine, let alone true anonymity. The function of a cryptocurrency address is similar to that of a username, email address, phone number, or bank account number. Once a user interacts with others or entities, those parties can associate the pseudonymous wallet address with a specific user, thereby exposing the user's entire on-chain transaction history and potentially revealing their personal identity. For example, if a store accepts cryptocurrency payments from customers, the cashier can see those customers' previous shopping records elsewhere and their cryptocurrency holdings (at least the wallet balance on the blockchain network used for that specific transaction, and savvy cryptocurrency users often have multiple wallets and tools). This is akin to making your credit card usage history public.

The Bitcoin white paper initially mentioned this risk, stating that "if the identity of the key owner is revealed, the correlation may expose other transactions belonging to the same owner." Ethereum co-founder Vitalik Buterin also wrote about the challenges of "making a large part of life publicly available for anyone to view and analyze," proposing solutions such as “privacy pools”—using zero-knowledge proofs, users can prove the legitimacy of the source of funds without disclosing the complete transaction history. For this reason, many companies are developing solutions in this field, not only to protect privacy but also to create new application scenarios that combine privacy with the unique attributes of blockchain.

Misunderstanding 4: Blockchain privacy fosters rampant crime

Truth: Data from the U.S. government and blockchain analysis companies show that the proportion of illegal financial activities using cryptocurrency remains lower than that of fiat currency and other traditional financial methods, with illegal activities accounting for only a small portion of total blockchain activity (related data can be found here, which we will discuss in detail below). This data has remained consistent over the years. In fact, as blockchain technology has continued to evolve, the proportion of illegal activities on-chain has been on the decline.

It is undeniable that illegal activities accounted for a significant proportion of the Bitcoin network in its early stages. As researcher David Carlisle cited the observations of Sarah Meickeljohn, “There was a time when the primary Bitcoin addresses used by 'Silk Road' contained 5% of all existing Bitcoins, and that site accounted for one-third of Bitcoin transactions in 2012.”

However, the cryptocurrency ecosystem has since successfully introduced effective mechanisms to reduce illegal financial activities, with the overall volume of legitimate activities significantly increasing. According to the latest report from TRM Labs, the volume of illegal transactions in 2024 and 2023 accounted for less than 1% of the total cryptocurrency transaction volume (based on the dollar value of funds stolen by cryptocurrency hackers and the dollar value flowing to blockchain addresses associated with illegal categories). Chainalysis and other blockchain analysis companies have also released similar estimated data (including data from earlier years).

Similarly, government reports, particularly those from the Biden administration's Treasury Department, have revealed the advantages of cryptocurrency in terms of illegal financial risks compared to off-chain activities. In fact, the Treasury's recent discussions on cryptocurrency—including its “2024 National Risk Assessments”, “Illicit Finance Risk Assessment on Decentralized Finance”, and “Illicit Finance Risk Assessment of Non-Fungible Tokens”—all point out that, in terms of transaction volume and amount, most money laundering, terrorist financing, and proliferation financing still occur in fiat currency or more traditional financial methods.

Moreover, many of the transparent features of blockchain (such as those discussed in Misunderstanding 3) make it easier for law enforcement to catch criminals. Because the flow of illegal funds is visible on public blockchain networks, law enforcement agencies can track the flow of funds to "cash-out points" (i.e., nodes where cryptocurrency is exchanged for cash) and blockchain wallet addresses associated with wrongdoers. Blockchain tracking technology has played a significant role in combating illegal markets, including the shutdown of illegal platforms such as Silk Road, Alpha Bay, and BTC-e.

As a result, many criminals have realized the potential risks of using blockchain to transfer illegal funds and have chosen to continue using more traditional methods. While enhanced blockchain privacy may make it more challenging for law enforcement to combat on-chain criminal activities in some cases, new cryptographic technologies are continuously evolving, capable of both protecting privacy and meeting law enforcement needs.

Misunderstanding 5: Combating illegal finance and protecting user privacy cannot coexist

Truth: Modern cryptographic technologies can simultaneously meet user privacy needs and the information and national security needs of regulatory and law enforcement agencies. These technologies include zero-knowledge proofs, homomorphic encryption, multi-party computation, and differential privacy. Among these, zero-knowledge proof systems may hold the most potential to achieve this balance. These methods can be applied in various fields to curb crime, enforce economic sanctions, and prevent surveillance of citizens, as well as the use of the blockchain ecosystem for theft or money laundering.

Zero-knowledge proofs are a cryptographic technique that allows one party (the prover) to prove to another party (the verifier) that a statement is true without revealing any information other than the truth of that statement. For example, to prove that someone is a U.S. citizen, a person can use a zero-knowledge proof to demonstrate this without showing a driver's license, passport, birth certificate, or other information. Through zero-knowledge proofs, this fact can be confirmed while avoiding the exposure of specific or additional information—such as address, birth date, or indirect password hints—thus protecting privacy.

Given these characteristics, zero-knowledge proof solutions are one of the best tools to help detect and curb illegal activities while protecting user privacy. Current research indicates that privacy-enhancing products and services can reduce risks through various methods, including:

1. Deposit screening: Preventing deposits of assets from sanctioned individuals or wallets;

2. Withdrawal screening: Preventing withdrawals from sanctioned addresses or addresses associated with illegal activities;

3. Voluntary selective de-anonymization: Providing options for individuals who believe they have been wrongly added to a sanctions list, allowing them to disclose transaction details to specified or selected parties;

4. Involuntary selective de-anonymization: Involving a gateway entity (such as a nonprofit organization or other trusted institution) in a private key-sharing arrangement with the government, where the gateway entity is responsible for assessing government requests to use private keys to de-anonymize wallet addresses.

Under the concept of “privacy pools,” Vitalik Buterin and other supporters also advocate using zero-knowledge proofs to allow users to prove that their funds do not originate from known illegal channels without disclosing the entire transaction graph. If users can provide such proof when converting cryptocurrency to fiat currency, then exchange nodes (such as exchanges or other centralized intermediaries) can reasonably ensure that these cryptocurrencies are not proceeds of crime while users retain the privacy of their on-chain transactions.

Although critics have often questioned the scalability of cryptographic privacy technologies like zero-knowledge proofs in the past, recent technological advancements have made them more practical for large-scale implementation. By reducing computational overhead, scalability solutions are enhancing the efficiency of zero-knowledge proofs. Cryptographers, engineers, and entrepreneurs are continuously improving the scalability and usability of zero-knowledge proofs, making them an effective tool to meet law enforcement needs while protecting individual privacy.

Misunderstanding 6: Blockchain privacy only applies to financial transactions

Truth: Privacy-preserving blockchain technology can unlock a wide range of financial and non-financial applications. These capabilities highlight how privacy-protecting blockchain technology fundamentally expands the scope of secure and innovative digital interactions, covering various application scenarios. Here are specific examples:

Digital Identity: Privacy transactions enhance digital identity verification capabilities, allowing individuals to selectively and verifiably disclose attributes such as age or citizenship without exposing unnecessary personal data. Additionally, in medical applications, digital identity can help patients protect the confidentiality of sensitive information while accurately conveying appropriate test results and other data to doctors.

Gaming: Cryptographic technology enables developers to create more engaging gaming experiences, such as unlocking certain hidden items or levels after players complete specific actions. Without privacy tools, blockchain-based virtual worlds would be completely transparent to users, diminishing their sense of immersion; when players are fully aware of everything in the digital world, their motivation to explore diminishes.

Artificial Intelligence: Privacy-preserving blockchain tools open up new possibilities for artificial intelligence, allowing for encrypted data sharing and model validation methods without disclosing sensitive information.

Finance: In the financial sector, cryptographic technology enables decentralized finance (DeFi) applications to offer more diverse services while maintaining privacy and security. New designs for decentralized exchanges can leverage cryptographic technology to enhance market efficiency and fairness.

Voting: In decentralized autonomous organizations (DAOs), the privacy of on-chain voting is crucial to avoid negative repercussions from supporting unpopular proposals or to prevent groupthink resulting from mimicking the voting behavior of specific individuals.

These are just a few obvious application scenarios for privacy-preserving technology; just as with the development of the internet, once privacy protection features are realized, we expect to see a surge of innovative applications.

The debate about privacy—who controls it, how to protect it, and when to relinquish it—has existed for at least a century, long before the digital age. Every new technology has sparked similar panic at its inception: telegraphs and telephones, cameras and typewriters have all prompted discussions that have influenced society for generations.

To believe that blockchain will only jeopardize privacy or that it is particularly susceptible to being used as a weapon for wrongdoing is a misunderstanding of history and technology. Just as cryptographic technology and protocols have enabled secure online communication and commerce, emerging privacy-preserving technologies such as zero-knowledge proofs and advanced encryption can also provide practical solutions for achieving compliance goals and combating illegal finance while protecting privacy.

The real question is not whether new technology will reshape privacy, but whether technologists and society can rise to the challenge by implementing new solutions and practices to adapt to change. Privacy is not lost or compromised; it is adapted to the broader pragmatic needs of society. This technological revolution, like previous revolutions, raises the fundamental question of how to achieve this adaptation.

For the complete cited paper, please see here.

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