Privacy and transparency in public blockchains

Market Insights Oct 21, 2021

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Public blockchains offer interesting and somehow contradictory characteristics with features protecting privacy while at the same time guaranteeing the transparency of transactions. In this paper, we will dig further into those concepts to understand better how blockchain is revolutionising the way people interact and do business.

‌‌A public blockchain network is per definition completely open: anyone can join and participate both in the network and the consensus protocol. On the other hand, a private blockchain doesn’t allow all participants in the network. Bitcoin and Ethereum are the two largest public blockchain networks in production today.

‌‌Privacy

Within digital assets, anonymity is an essential feature for data protection and data ownership. In a public blockchain, privacy is secured by public addresses: a person is only linked to a public address that does not reveal personal information such as actual name or address. The public addresses act as pseudonymous identities, for that matter, it is commonly said that a public blockchain is not completely anonymous but rather pseudonymous.

‌‌Transparency / Traceability

The way a public blockchain functions is transparent as every node on the network stores a copy of the transactions and verifies that no rules are being broken. Anyone can see live and historical transactions and can search through blocks, transactions and addresses. Each node has its own copy of the chain that gets updated as fresh blocks are confirmed and added. This means that it is possible to track a coin wherever it goes. Therefore, if an exchange was to be hacked, the crypto extracted would be easily traceable, even if the hacker remains entirely anonymous.

‌‌With the fast-rising pace of decentralised finance, and despite the traceability features of public blockchains, some express concerns over illicit transactions and lack of regulatory authority.

‌‌KYT to improve the traceability of public blockchains

‌‌One way to improve transactions’ traceability is through the use of Know Your Transaction (KYT). Know Your Customer (KYC) is already a central element in the customer onboarding process and risk-based transaction monitoring. Required by regulators as an integral part of AML, it has lately become the norm in digital assets centralised exchanges.

‌‌On top of KYC, we now observe a rise in the use of KYT aiming at identifying potentially risky transactions and unusual behaviour to detect money laundering, fraud or corruption. Within blockchain technology, the focus is not on the person but the transaction, on its historical attributions and all the connections to that transaction. It is not only about monitoring a customer but rather about monitoring the flow of funds through an address to assess the legitimacy and legality of that transaction.

‌‌The use of private coins for greater privacy

‌‌While for some the traceability of transactions is primordial to prevent corruption and illicit operations, others are focusing on their privacy and use various privacy-enhancing technologies that ensure full anonymity.

‌‌Privacy coins such as Monero (XMR), dash or zcash have additional anonymity built into them and offer privacy features that are important to many cryptocurrency users. Monero, released in 2014, states in its white paper that privacy and anonymity were the most important aspects of this digital currency.‌‌

But there are some limitations in the use of private tokens. Regulators have seen the enhanced privacy features as conflicting with AML and KYC regulations. Therefore, they are not as liquid as other cryptocurrencies as many regulated exchanges have chosen not to list them due to regulatory concerns. They are more vulnerable to regulatory scrutiny and data analysis companies, such as Chainanalysis, can refuse to perform a reasonable level of compliance analysis on them. Finally, privacy coins, in some cases, have been seen as giving cybercriminals greater freedom from tracking tools and mechanisms available on public blockchains. Monero, in particular, has become the cryptocurrency of choice for the world’s top ransomware criminals and was also a popular choice on AlphaBay, a massive underground marketplace popular up until it was shut down in 2017.

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Caroline Jacquard

Seasoned marketing manager with 15+ years of experience in the financial industry: traditional finance, alternative investment and digital assets. Advisor @trakx.io