Privacy is significant to Crypto – and therefore the Global Economy
The following article originally appeared in CoinDesk Weekly, a custom-curated newsletter delivered every Sunday exclusively to our subscribers.
Imagine if flour millers insisted on knowing the precise identity and originating farm of every grain of wheat delivered to them.
It would render the worldwide wholesale crop market dysfunctional. That market depends on buyers accepting products from warehouses and shippers albeit they don’t know their origins.
At the guts of this technique is that the ancient principle of fungibility: the thought that one unit of a specific product is perfectly interchangeable with another.
This principle depends upon an unspoken agreement between market participants that information a few product’s history isn't only hidden but is really lost. A product having this quality is, more or less, the very definition of a commodity.
Fungibility is even more important to money. Our system of cash requires that every dollar be completely interchangeable with the other dollar. For it to function perfectly, users can haven't any knowledge of the history of every of these dollars.
I like to define money as a communication system that uses a commodity (the currency) to convey information about transfers useful . If the commodity’s fungibility is challenged, the facility to speak that information is diminished.
You could say that assuring the fungibility of a currency may be a matter of free speech. even as importantly, the breach of freedom means the system of exchange itself breaks down.
It’s all about privacy
It boils right down to privacy. Without the history of transactions being obscured, money doesn’t function so well.
If we knew where every distinct unit of currency had been, it might assume the standard of a definite , identifiable sort of property. which would go away our money subject to liens and asset seizures by creditors or enforcement agents taking actions against people .
This is critical to the argument around privacy within the blockchain and cryptocurrency communities.
Unless you’re taking note of the outdated, false talking points of some anti-crypto crusaders, you’ll know by now that bitcoin, which keeps a record of each single input and output, isn't very private. (If you’re getting to do an enormous drug or deal that you simply want kept out of view, it’s far better to use a briefcase filled with Ben Franklins, not bitcoin.)
This aspect of bitcoin raises serious questions on its fungibility.
The same questions will arise round the myriad new blockchain platforms for exchanging digital assets. For these systems’ crypto-economic incentive and governance models to satisfy a promise to resolve trust problems and enhance community coordination, their tokens must be fungible. (Note: this interchangeability is required even when the token represents a claim on a bit of distinct, underlying property, like a share during a piece of land .) which means they too must address the privacy dilemma.
Even as the understanding of bitcoin’s privacy limitations improves, and as mathematicians like Blockstream’s Andrew Poelstra seek to beat them, the general public debate over this matter still mostly misses the larger point of fungibility.
As cryptographic tools for enhancing privacy are incorporated into cryptocurrency projects, including zero-knowledge proofs (zcash), ring signatures (monero) and bitcoin mixers, the talk over their value to society is just too narrowly viewed as a battle between privacy as a person's right the one hand and society’s got to prevent criminality on the opposite .
But serious cryptographers performing on these tools make a much bigger and more important claim: privacy is required to reinforce the “moneyness” of cryptocurrency.
It is a vitally important task, because, as it is, our entire global system of cash has also seen its fungibility deteriorate, precisely because privacy has been eroded.
Even though, for the foremost part, a dollar remains treated as interchangeable with the other dollar, increasingly stringent anti-money laundering rules are undermining that system.
The cost of compliance
It began well-intended, with the U.S. Bank Secrecy Act of 1970, which needs banks to spot customers before permitting them to use their services and to, effectively, monitor their behavior.
The BSA became a strong weapon within the U.S. within the War on Drugs, and its principles became ever-more ingrained into our economic system . There’s now an elaborate global system of outsourced monitoring aimed toward using money trails to catch bad guys.
It’s debatable how successful these programs are . The United Nations Office on Drugs and Crime estimates that up to $2 trillion is laundered annually, or 5 percent of world GDP. Governments’ answer thereto problem has, predictably, been to feature even more surveillance and compliance requirements.
What is clear is that each one these rules find yourself curtailing the flow of cash round the world, especially that of honest actors.
Since the 2008 financial crisis, and following some heavy fines against banks that serviced drug cartels or addressed sanctioned entities on the Office of Foreign Assets Control (OFAC) list, “know-their-customer” (KYC) identification requirements became a serious cost drain for many banks.
These compliance costs are now so burdensome that a lot of are pulling back from perfectly reasonable businesses that their compliance officers deem “risky.” Entire regions like the Caribbean have suffered debt crises due to this “de-risking” problem.
Banks might still function somewhat like those grain warehouses, bundling deposits during a way that doesn’t distinguish one dollar from another. But i might argue that this excessive compliance process has, in effect, made the worldwide medium of exchange less fungible. A dollar transmitted by an “unbanked” individual within the Bahamas is now worth but a dollar wired by a totally “KYC-ed” U.S. bank client.
Bitcoin promised how around this problem. There was no got to personally identify oneself to realize access to bitcoin currency; you simply had to download the software and generate a public key that contained no identifying information. Many folks saw it as an answer for the unbanked of the developing world.
But since bitcoin wasn’t widely employed by the overall public, users inevitably had to interchange coins with fiat currency, which meant interfacing with the banking industry . Once bitcoin wallets and exchanges were subject to KYC rules, they created identifiable on- and off-ramps, which, when combined with bitcoin’s permanent, immutable, blockchain ledger, created a clearly traceable record of each bitcoin transaction.
This is how the U.S. Department of Justice caught those rogue United States Secret Service agents who thought they might abscond with bitcoins seized in their investigation of Ross Ullbricht, the convicted founding father of the Silk Road marketplace.
We’ve already seen how bitcoin’s traceable history undermines fungibility. When the FBI launched a series of auctions of bitcoins seized therein same investigation, it attracted giant bids that put a better price on bitcoin than that quoted on exchanges.
Why? Because these were “whitewashed” coins; no G-man would seize these again. It seems that one bitcoin are often more valuable than another.
Imperfect fungibility means people will tend toward holding bitcoin as a speculative asset instead of using it as a medium of exchange. Speculation is all well and good, but if bitcoin can’t be used for purchases, it’s an impractical sort of money.
Privacy = freedom = a healthy economy
Yet because governments are unwittingly creating an equivalent problem with their own money, cryptographers performing on privacy solutions for cryptocurrencies have a chance to reinforce economic activity, not only within the world of crypto, but the planet over. In doing so, they’re also striking a blow for freedom.
That’s because privacy isn't only critical for monetary fungibility, it's the inspiration of freedom. within the years ahead, as economic activity becomes increasingly digital, i think this duality of privacy and freedom, measured by how easily our worth exchange systems allow us to transact with one another , will become the defining differentiator between economic systems.
Consider China. The rapid expansion of digital payments there, led by Alibaba’s Alipay and Tencent’s WePay, has caught the world’s attention. It’s driving other governments to vow to make “cashless societies.”
But because the Chinese government expands its surveillance state, replete with its ominous “social credit score” measuring and incentivizing citizens’ behavior, the traceability of these digital payments looks quite worrying.
At what point does a digital transaction model’s threat to privacy, fungibility and economic activity outweigh its ease-of-use advantages? This, I believe, might be the defining issue during a global competition between open versus closed economic models.
So let’s applaud and support the work of those pro-privacy cryptographers. they're building out a core feature of our future digital economy’s infrastructure, one that’s needed to both protect citizenry and enable exchange among them.