By Awa Sun Yin, Co-founder of Anoma & Namada
Centralized exchanges are becoming an increasingly popular method to achieve a level of privacy among users. If this sounds counterintuitive it’s because it is; we’ve been “schooled” to think that decentralization is the way to go for privacy. So why — and how — did we get to the place where the average user turns centralized exchanges into crypto mixers?
The most common misconception about crypto is that it provides total anonymity. If you go fully decentralized, according to this belief, it is possible to conduct all sorts of financial transactions without leaving a trace, a la Mr. Robot. So, why does everyone not just open a MetaMask wallet and go completely off the grid?
Because, in reality, most decentralized blockchains provide pseudonymity, not anonymity. And, it has a quite different take on privacy. Pseudonymity enables creating a decentralized wallet and sending or receiving crypto assets on different blockchain networks without sharing personal information. However, staying below the radar of the government or intermediaries comes at a cost.
Each transaction leaves an immutable mark on the blockchain that contains wallet address info, and it takes mere seconds for the user at the other end of a transaction to see the wallet address of the sender or receiver.
Once a wallet address, or a pseudonym, is associated with a crypto user, the whole blockchain ecosystem turns into an account book of that person, showing all of their transaction history across different networks. According to a recent survey, a whopping 84% of respondents are concerned that their wallet addresses can be linked to their identities.
Source: Cointelegraph Consulting
Workarounds for pseudonymity
Having transaction history publicly available is way more problematic for businesses than it is for individuals. The fragile nature of business relationships can be easily damaged by seeing the discount the next vendor gets each month. Let’s take a relatively smaller business with around ten vendors expecting monthly crypto payments as an example.
Should the company choose the decentralized way, it needs to take a bunch of extra steps to cover its transaction history from unauthorized eyes. It needs to create ten new crypto wallets for each vendor and back up each seed phrase. Each wallet should be labeled as Vendor A, B, C, etc., to clarify which wallet is used to conduct business with which vendor.
After depositing crypto funds into each of those ten wallets separately, either from a centralized exchange or via a fiat gateway, the company needs to create one payment transaction per wallet and double-check that at all times to ensure the right wallet is used for the intended vendor.
This way, even if it is revealing the information about ten hot wallets and the transaction histories to the centralized exchange or the fiat gateway, at least the company won’t leak business-sensitive information to its vendors and everyone else who has access to a block explorer.
Practical-but-centralized privacy
Long story short, staying even relatively private in the decentralized world requires an effort that can only be matched by what Gene Hackman’s Brill was doing in the 1998 movie Enemy of the State. Otherwise, users are one doxxing away from getting their full financial history -including NFTs- exposed to the rest of the world. It’s impractical, risky and highly vulnerable to mistakes —especially in a business environment.
Instead, what most people do is pay directly from a centralized exchange like Kraken or Coinbase. This saves them from all the hassle mentioned and it gives them the practical privacy that the average crypto user needs. Because when you pay from an exchange, the only thing your recipient will see is that the payment comes from an exchange. Only your recipient can understand that you made this payment – but to everyone else on the internet, this looks like one of many transactions coming from an exchange.
This is why centralized exchanges serve as the most commonly used mixers — even though that’s not their intended use. The average crypto user doesn’t mind the government or exchanges knowing what they do with crypto, but they don’t want to reveal their payment history to their business partners, competitors, customers, followers on social media, friends or families.
The crypto industry needs to move towards better privacy without sacrificing decentralization. Thankfully, zero-knowledge cryptography is becoming more and more reliable and accessible as an alternative. Zero-knowledge proofs allow users to verify identity or transactions without giving away any context about it. With recent developments, it’s now possible to generate proofs on web browsers or smartphones.
For crypto to replace traditional finance, it has to provide at least the same level of privacy as traditional infrastructures. It’s hard to imagine real-world businesses moving to crypto when their entire transaction history is visible to anyone. In a world where the average user manages assets across multiple blockchains and prioritizes privacy from the environment over privacy from the government, it’s crucial for the crypto ecosystem to pay attention and comply with users’ needs.
Author bio
Awa Sun Yin is a Co-founder of Anoma & Namada, a Director at Heliax. Awa joined Chainalysis as the first female data scientist and software engineer in 2017, after working on papers on using on-chain data to de-anonymise Bitcoin. Awa joined Tendermint/Cosmos as a researcher, and helped out with the Ethereum Community Fund initiative in 2018-2019. Ever since, Awa has co-founded and built several ventures.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.