Published on December 20th, 2021 | by Bibhuranjan0
2022: The year of blockchain privacy?
In the realm of blockchain technology, a large part of 2020 and the whole of 2021 was all about decentralized finance (DeFi). Decentralized finance aims to answer the question of what a world without traditional banks would look like? As the name suggests, decentralized finance is simply finance in the context of the blockchain. At the beginning of November this year, there was €175 billion worth of assets locked up in the DeFi ecosystem.
As of December 2021, the market capitalization had pulled back down to $152 million, nothing strange when looking at the volatility of the crypto markets. Just typical fluctuations relating to the broader crypto markets, and mainly Bitcoin. Regardless of what happens in the next couple of weeks, DeFi is poised for further growth throughout 2022 and beyond. It is still in its infancy, and one of the biggest blockers to mainstream adoption is related to privacy. It all relates to the fact that the activity on the blockchain is public, with immutable records and complete transparency. This transparency has unintended consequences, causing issues in DeFi networks and applications. A couple of which you can read about further down.
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The good thing is that privacy is fixable, and existing solutions in web 2.0 are far from perfect. Web 2.0 is at best conditional with tech organizations tracking, analyzing and distributing personal data. Additionally, data breaches occur regularly, where personal data is leaked into the wrong hands. Web 3.0 can do a far better job, and for DeFi to gain mainstream adoption, privacy needs to be put in focus.
Optional blockchain privacy
A common narrative outside the blockchain is that cryptocurrencies are tools for illegal activities and money laundering. A narrative that doesn’t hold much ground. Matter of fact, the activity that takes place on most blockchains are public. Bitcoin, Ethereum, Solana, Cardano, and Cosmos Network – they are all public by default. The notion that Bitcoin and these other blockchains are anonymous is also false. Each person interacting with Bitcoin uses an address; this address is a pseudonym that is linked to the transaction made. And that transaction is stored forever in the blockchain. Pseudonymity shields who someone is, in the case of an address, the person behind it can be traced as the address interacts with different applications to make purchases or receive goods.
Potentially, this means that it is possible to match a blockchain address with the identity of a private person or organization. Not an ideal scenario.
This means that there is a great need for blockchain privacy to allow for financial use cases on the blockchain. But the privacy needs to be optional so that the owner of a blockchain address can choose to share details if they want to. That would also allow regulators and governments to probe certain transactions and blockchain addresses when deemed necessary by the law in order to abide by anti-money laundering laws and other regulations.
Privacy blockchains remove front-running issues in DeFi
Front-running is an activity that can occur in blockchain transactions. It can be compared to a person acting on inside information when buying or selling shares of a public company, where the person has an unfair advantage against the rest of the market. Company A plans to make an offer on Company B. This information is not known outside the C-level management of the respective company. The information is not known to the public. Ahead of the offer, a board member of Company A purchase shares in Company B. Once the offer is public, the shares of Company B goes up in anticipation of the buyout. The board member acted on insider information, which is illegal.
The same principles are at play in a front-running attack on the blockchain, where information is used to create an unfair advantage. As mentioned earlier, a transaction on the Bitcoin blockchain, for example, is visible, and a transaction is known before it is finalized. This leaves a small space for an actor in the network to put their transaction before another transaction. For example, a purchase order is made for a number of tokens at a given price, a font-running attack could copy that order but put their transaction ahead of the original. Effectively, using the information to get unfair advantages over “regular” participants in the network.
In this regard, privacy can help by encrypting inputs and outputs of contracts, where an unprocessed transaction has details private, and only when processed are the full details known. Which effectively would prohibit a front-running attack since it would be too late to act when the transaction is being processed.
Privacy is key to the success of DeFi
In 2017, the DeFi market was worth $36 million. In 2018, $3.2 billion. In 2019, $1 billion. At the beginning of 2020, the DeFi market was worth $1.9 billion. Since then, it has exploded. At the start of 2021, it was worth $21 billion, and as we wrote at the beginning of this article – right now, the DeFi market is worth $152 billion. Despite this growth, DeFi has a long way to go, not the least in ways of replacing traditional banking services. For any of this to happen, privacy needs to be available by default while also having the optionality to show data when needed. This would give true ownership of data to each user while also inviting governments and regulators to check the data whenever deemed necessary by the law.
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