Bitcoin reveals everything. When one party hands a $5 bill to another, the fungible quality of the note creates a firewall separating the transaction from the personal finances of the transacting parties. Transferring $5 in bitcoin, on the other hand, unlocks the vault doors of both parties – allowing each to peer deep into the personal financial history of the other.
Imagine sharing a restaurant bill with a friend; she pays the total amount on her credit card, and you hand her $25 in cash for your share of the lunch bill. The transaction to split the bill raises no privacy concerns because the cash transferred from one friend to the other reveals nothing about the transacting parties private finances. Cash is fungible; there are no distinguishing characteristics about a $20 bill held by a person that links the note to the person or their financial history. The bill is an independent instrument that is interchangeable with any other $20 note. There is no such thing as a Jane Doe $20 bill or a John Doe $5 bill. However, when bitcoin is transferred from one party to another, not only does the sender expose her entire financial history to the recipient – the recipient also does the same. Bitcoin is not fungible; every bitcoin or fraction thereof that is transacted, is permanently linked to the bitcoin addresses that it interacts with – from the moment that the bitcoin was mined into existence. Bitcoin’s architecture is based on a transparent public ledger by design. This approach works well for applications where it is desirable to maintain a transparent accounting of transactions that can be accessed by any person with a computing device. However, I am going to go out on a limb and wager that most people would not be in favour of exposing their personal finances to the extent that bitcoin does. Let’s take a look at some examples to evaluate my supposition.
In the bill-sharing scenario that I set out above, the two friends would handle the bitcoin transfer of $25 with a cryptocurrency wallet app on their smartphones. The transaction would be recorded to the public ledger in an entry that would include the sender’s bitcoin address, the recipient’s bitcoin address, and a unique transaction number. This information is all accessible directly from the app or by browsing a blockchain explorer (there are a few to choose from). Now let’s suppose that the recipient searched for the transaction number on the public blockchain – they would see details of the full transaction. By simply clicking on the sender’s bitcoin address, the recipient would see the current balance in the account. The sender may treat his smartphone cryptocurrency wallet the same way that he would treat a fiat currency wallet; holding only $100 at any given time and storing his savings in a savings cryptocurrency wallet. Unfortunately, this exercise of diligence gains him no benefit in protecting his savings balance. The public ledger not only allows the recipient (or any other person) to see the balance in the sender’s address, it also displays the source address that funded the sender’s smartphone wallet. Simply clicking on the source address will reveal how much money the sender has in his savings account. This process can be repeated to the provenance of each bitcoin. Moreover, either party in the transaction can trace the others accounts and view balances. A bitcoin is created, and it appends every wallet address that it is transferred to throughout its history – making every bitcoin unique, not fungible like fiat currency.
Expanding on this notion of exposed privacy, we note that there is no KYC (Know Your Client) for bitcoin users. Therefore, when a user pays bitcoin to an unscrupulous party – there is nothing stoping the receiver from looking into the personal finances of the payer, and maliciously targeting him or her if there is a sizeable value in his or her account.
Bitcoin’s blockchain does not include the names of people who transact, only their bitcoin addresses. This led many to believe that bitcoin was anonymous. But as we see in the example that I set out above, once the owner of an address becomes known – viewing the equivalent of their transparent bank accounts, balances, and transactions is an effortless task.
Stablecoins may have an even greater hurdle to overcome. The centralized issuance of programable digital currency means that from day one the central authority not only knows who owns each digital currency, but also every person or entity that each user sends or receives funds from. If a user buys a coffee every day from their favourite coffee shop, the issuer of the stablecoin has the ability to store every transaction – no matter how small – with names. Innovation has increasingly found ways to offer value that consumers pay for by giving up some degree of privacy. How much privacy consumers will be willing to give up as it relates to their financial transactions in a tokenized economy remains to be seen. It may take a newsworthy abuse of power by a custodian of this information, or a significant privacy incident before users take note. Forward-thinking participants should consider the implications and communicate to current and future users just how they plan to secure the privacy of their stablecoin user community.
This discussion would not be complete without a word concerning solutions that have been put forward by privacy-oriented cryptocurrency projects such as Monero, Dash, and Zcash. Sharing the bill using Monero, for example, would be as private as using cash. However, the level of privacy and security around a digital currency such as Monero, poses challenges for AML (Anti-Money Laundering) regulations, as the default configuration of the protocol blocks viewing of transaction details. I suspect that from the many brilliant innovative minds at work within the cryptocurrency community, a solution will emerge that strikes a balance between privacy and regulatory compliance. The journey continues.