Privacy coins and sanctions are a weird combination
One of the earliest use cases for cryptocurrencies was the ability to make a payment in complete privacy. After all, the possibility of guaranteeing a transaction between two unknown parties has been one of the Holy Grails of encryption. This is also why there still seems to be a lot of confusion around the fact that Bitcoin can easily be used by criminals in order to conduct illegal activities. Anonymity is not the same thing as privacy.
The current war in Ukraine and the subsequent economic sanctions have brought up a lot of discussion surrounding the merits, or lack thereof, of centralized financial institutions and the possibility to outright lock a person or a country out of its finances. There was quite a scene made around Russia using crypto to avoid sanctions. Using a distributed, transparent and permissionless network where every transaction can be monitored in order to move around huge quantities of money is hardly a good idea. I have gone more in detail on this topic in a short interview for VIXIO.
But before going into how sanctions could be avoided (or not), let’s do a little dive into what privacy coins are, how they work and what are some of the more successful ones.
Privacy Coins in a (encrypted) nutshell
Any anonymous transaction on a public ledger will, at some point, come into contact with an address or a centralized exchange that requires KYC. From that point on, it’s only a matter of time and “following the money” backwards in order to pinpoint the source of the transaction. Explorers like etherscan.io or blockexplorer.com are filled with addresses of known scammers or hackers that are followed by FinCrime institutions or crypto vigilantes, waiting for them to move funds through a single point of failure or traceable exchange. This is especially the case for pseudonymous public ledgers like Bitcoin and Ethereum.
Privacy coins, on the other hand, are built to obscure information as much as possible and make it a lot more difficult to make out who sent what to whom. Being private is effectively being untraceable, or close to it. Cryptocurrencies like Monero (XMR), PIVX (PIVX), Dash (DASH), or Zcash (ZEC) use a variety of cryptographic techniques to obscure, hide or limit the information available on a transaction and/or the sender/receiver, such as:
ZK-SNARKs — (Zero Knowledge Succinct Non-Interactive Argument of Knowledge) A method that allows a sender to prove to the receiver that a certain statement is true, thus rendering trust between parties irrelevant while keeping the information itself hidden.
Stealth Addresses — Require the sender to generate a new address every time they execute a new transaction so as not to be linked to a single receiving address. These function as effective one-time safety deposit boxes, used only once.
Mixers — Methods such as CoinJoin blend together transactions from different senders and then redistribute them accordingly to their respective receivers.
Ring Signatures — Transactions are made to seem as if they used multiple outputs in order to be executed, when in reality only one was used. Several “decoy” outputs are taken from completely different transactions and made to seem as if they are legitimate. Outside observers have no idea what transaction is actually being executed.
CoinJoin Transactions — More specific mixer-type transactions, CoinJoin functionality was first offered back in 2014 by the Dark Wallet alpha version. The process anonymizes Bitcoin transactions, provided the senders and receivers agree to coordinate. This is more of a type of non-custodial transaction that users can initiate and less of a full-on service.
There is a plethora of privacy coins out there to choose from, and most of them use one or multiple encryption and obfuscation methods, some like those described above. Privacy coins compete in the same way other Layer 1s, gaming or security coins and projects compete. Here are some of them and how they function:
Monero (XMR) — The most well known and most widely used privacy coin, Monero uses a combination of stealth addresses and ring signatures to hide transaction details. The transaction amount is also concealed by using Ring Confidential Transactions (RingCT). XMR is a 2014 Proof-of-Work fork of Bytecoin.
ZCash (ZEC) — The first practical application of ZK-SNARKs, its privacy guarantee comes from the fact that it can fully encrypt transactions on the blockchain but still verify them through the network’s consensus rules. Transaction amounts can be hidden, and users can opt to not reveal each other’s addresses.
Dash (DASH) — Most well-known for allowing users the option to choose between the transaction being anonymous or private through a feature called PrivateSend. The network uses a mixer that runs on master nodes (a special server within a network of servers that validates blocks).
Verge (XVG) — Most popular for using The Onion Router (TOR) Invisible Internet Project (I2P) to guarantee privacy, Verge essentially encrypts and then bounces user’s transactions between a network of servers and relays. XVG was also in the news at some point for becoming officially accepted by a certain adult website with a certain well known intro song.
PIVX (PIVX) — A 2016 fork of DASH, PIVX stands for Private Instant Verified Transaction. It runs on Proof-of-Stake and uses the Sapling protocol that supports both shielded and unshielded transactions.
Beam (BEAM) — Beam is a private network focused on supporting confidential DeFi. By using the MimbleWimble and Lelantus MW protocols, the values and metadata of transactions are hidden. The blockchain runs on Proof-of-Work.
Could privacy coins help Russia avoid sanctions?
The answer to that question is more complex, however here is the very simplified one: Not really. The sanctions package that Western countries have imposed on Russia are complex, wide-reaching, and they target financial institutions, individuals and industries. In an oversimplified way, the sanctions do three things:
Damage Russia’s ability to produce money — The sanctions on the central bank and the now famous $650 billion “war chest”, of which half is essentially blocked. This cuts the country’s ability to prop up the ruble by buying it with other currencies on international markets. The central bank has some accessible funds on hand to keep the Russian currency up for a short while. The same is the case for the Moscow Stock Exchange, through outright market manipulation tactics such as banning short-selling. These measures are only temporary and can’t possibly go on for more than a couple of months to the intensity needed to keep what used to be the world’s 11th largest economy by GDP.
Damage Russia’s ability to move money — The SWIFT sanctions on a number of banks that make a very good portion of the financial world be inaccessible to Russian banks. This hits on individuals and businesses that were doing business with the outside world for example.
Increasingly move towards shrinking the Russian economy, especially the oil and gas sectors. This is intended to hit at the heart of the Russian economy, given how reliant the country is on its natural resource exports, with oil and gas accounting for roughly 40% of Russia’s federal budget revenues, up to 60% of its exports and make up to 80% of the economy of Khanty-Mansiysk, Russia’s unofficial oil capital. Speculating and guessing about what the Russian economy would look like one, five, ten or fifteen years in the future might be interesting, but it’s not the purpose of this piece.
Now back to privacy coins. At an initial glance, it might be easy to say that the Russian Central Banks, oligarchs or businesses could simply buy some Monero or Zcash, exchange these for some other cryptocurrencies or stablecoins, then sell those OTC (Over-the-counter) or on centralized exchanges via accounts made and held by proxies, then use the proxies to do business, sell oil and have everything like it was before. Right? Wrong.
Russian oligarchs have way too much money to move through a single exchange and while possible, laundering money and hiding the source of billions of dollars through Dash or PIVX is a lot more complicated than other current far more easily accessible options that they might have. Simply obfuscating the source of funds through crypto doesn’t do much once they need to be swapped for fiat currencies and used in big amounts in order to pay for five-figure rents or maintain private jets taxied in airports.
Living purely off of crypto is definitely possible in many places in the world as an individual. Being in crypto for so long, I have met nerds of all shapes and sizes who live in part or completely off of their crypto investments. While adding another layer of security on top of that through Monero or Beam could be of help if you need or want a bit more privacy, in the end, the tax man will still come to collect what is owed to him once purchases or services and products are made.
When it comes to the Russian financial institutions that were hit by the first waves of sanctions, the prospect of using crypto or privacy coins is even less efficient. Exchanging the fledgling rubble into privacy coins to then exchange those on centralized exchanges in sufficient quantities to trade on international markets is impossible to go unnoticed. More so, the second that any non-privacy-focused cryptocurrency address (Like Bitcoin or Litecoin) is used by Russian institutions, this can give an unprecedented access and information into how the institution operates. Information that can be used to make sanctions even more efficient.
To wrap it up, I am not sure how many individuals have a complete overall understanding of both how efficient sanctions are against Russia and how the Russian government is avoiding some of these. What I am sure of, however, is that using privacy-coins does not do much when it comes to hiding the source of funds in such immense quantities, or that are supposed to be used in the benefit of a sanctioned institution