Users vs. governments: The 'infinity war' for blockchain privacy may be over

The unique power of blockchain and cryptocurrency can also be considered their weakness. Crypto users gain unparalleled privacy for financial transactions through a decentralized transactional system. Governments, however, demand transparency in financial transactions for legal concerns. This creates a paradox. People are less inclined to use financial instruments if, in doing so, they expose their money to the world. Conversely, there are a number of regulations requiring financial institutions to counteract terrorism and money laundering — serious concerns for many governments.

The crux of the issue is that most public blockchains require a consensus of all participants to validate transactions. How can both sides — individual users and governments — achieve their conflicting objectives when they’re diametrically opposed?

A potential solution to this problem involves balancing the privacy concerns of users with the centralized oversight necessary for governments to ensure that regulations like Anti-Money Laundering, Know Your Customer and Combating the Financing of Terrorism are observed. Implementing measures for confidential transactions alongside those for governmental surveillance strikes a delicate balance in which cryptocurrency assets remain discreet yet subject to the laws governing finance around the world.

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Countering terrorism and money laundering

The government’s need to monitor cryptocurrency transactions for counterterrorism and AML purposes is critical for public safety, especially since these two areas are interrelated. Money laundering can be used to fund terrorist activities, which — like everything else — require funding, even if it doesn’t involve money laundering. Surveying the money flow between parties on popular cryptocurrencies like Bitcoin (BTC), Ether (ETH) and others can provide invaluable information for preventing these crimes. Regulatory bodies need insight into which parties are paying whom and why, at the very least.

However, cryptocurrency’s very nature makes it easy to mask these and other transactions. Bitcoin may be traceable with modern tools, but some transactions are completely untraceable with other cryptocurrencies. These legitimate concerns partly explain the formation of organizations like the Financial Action Task Force, which exists to counteract money laundering and terrorist financing, and whose efforts would greatly benefit from improved visibility into cryptocurrency transactions.

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Privacy matters

The general public’s privacy issues about using cryptocurrencies are, in many ways, opposed to the visibility the government requires for AML and terrorism efforts. People simply want to keep their business as discreet with cryptocurrencies as it is with conventional currency transactions. However, the transaction validation features of public blockchains can potentially expose this information, invading users’ financial privacy.

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The first element of a solution providing consumer privacy in tandem with governmental oversight is to redress this issue. There are confidential transaction features — some of which are used by cryptocurrencies Monero (XMR) or Zcash (ZEC) — that obfuscate the amount and participants of a transaction while still validating it for a blockchain. These cryptocurrencies provide measures to prevent people from knowing the origin, the destination and the amount of a specific transaction. These approaches assuage many of the privacy concerns of cryptocurrency holders.

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Cryptocurrency surveillance

By pairing these privacy methods with the following ideas for cryptocurrency surveillance, governments can monitor activity for counter-terrorism and AML purposes. Say, for example, there is a cryptocurrency backed by an organization consisting of a finite number of banks. The first thing users would have to do is onboard with those institutions — much as they would with any other — which provides an initial layer of insight into cryptocurrency behavior while supporting mandates like KYC. Then, after users issue transactions to others enrolled in this organization, they would be obligated to disclose the details to one of the banking members for proof. This obligation can be enforced on the transactor by the use of cryptography so that the validators can ascertain that the disclosure has been correctly made.

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Such an approach would enable the government to collectively ask each bank the particulars of a transaction so it can monitor the money flow. The government would therefore have central oversight courtesy of the individual financial institutions’ input. With this paradigm, the banks validate transactions, the government collects all the data for central analysis and surveillance, and consumer privacy is upheld among financial organizations and cryptocurrency users. There are additional cryptographic approaches that, when coupled with blockchain’s cryptographic underpinnings, can support this model for both privacy and regulatory adherence.

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Cryptocurrency usage is rapidly evolving. It’s unacceptable for financial institutions to tell national or international regulators that they don’t know whether transactions are legitimate. It’s equally unacceptable to expose the financial prowess of legitimate users to everyone on a blockchain.