The Coming Privacy Wars

Severe tensions have been unleashed in cryptoland since Ethereum-based mixing service Tornado Cash was added to the U.S. Office of Foreign Assets Control’s (OFAC) specially designated nationals (SDN) list last week. But this is just the beginning.

The move, which was prompted by allegations of North Korean hackers using the service, could set regulators on a collision course with privacy-seeking crypto users and with developers of the tools they use. One can imagine an intensifying clash enveloping crypto natives and mainstream users alike.

That’s because there are many reasons to expect a continued, growing demand for privacy – from an array of people far wider than the narrow subset of undesirables OFAC is aimed at. Let’s start with one that’s fundamental to currencies’ role as a medium of exchange: fungibility.

It shouldn’t matter which actual dollar you hold in your hand; it should be assigned the same value as any other dollar. A recipient can’t care which explicit unit of a currency he or she is handed. If money isn’t fungible like that, it can’t function.

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Privacy makes money money

Privacy is a prerequisite for fungibility. If distinct money units have a transparent, publicly known history, then there’s a risk they will be valued differently. If a particular bitcoin or stablecoin was at some point flagged for passing through the hands of some SDN-listed person, company or software service, then people will discount its value or simply refuse to accept it. Goodbye fungibility.

Last week, entrepreneur Maya Zehavi pointed out how, following the OFAC announcement, providers of crypto services started using on-chain analysis to block not only wallets that transacted directly with Tornado Cash, but also second-hop and third-hop wallets further down the chain whose mix of tokens was “tainted” by that up-chain association. Differing histories were now making certain tokens less desirable than others as they were at risk of being blocked.

How might users protect themselves from unintended tainting? Zehavi argued they will have to obfuscate all transaction history leading to their wallet. How? With a non-banned mixing service.

So, we can see how banning one mixer can fuel even more demand for replacement services and incentivize developers to create them. We can also see how it might create an accelerating cycle of bans on mixers and new ones popping up to replace them. (It’s worth noting, as a counterpoint, my colleague Dan Kuhn’s argument that anyone seeking to clone Tornado Cash’s open-source code has the difficult task of winning the community’s trust and avoiding government crackdowns.)

Read more: What the Tornado Cash Sanction Means for Privacy Coins

Privacy for good

Beyond fungibility, there are all sorts of other social, political and strategic motivations for decent people to seek privacy.

Those living under oppression, for example.

In response to a querying tweet from Jeff Coleman last week, many people, including Ethereum co-founder Vitalik Buterin, said they would have used Tornado Cash to send funds to Ukraine causes to avoid having them intercepted either by Russian authorities or by Western authorities who worried that the funds might fall into Russian hands.

Similar principles were behind the Women’s Annex project, which in 2013-2014 paid young female Afghan computing students in bitcoin to avoid having their fathers, uncles, brothers or other male figures intercepting the funds.

The payments weren’t privatized through a mixer, but in those days, they didn’t need to be to fulfill their intended obfuscating function. All that changed when the New York Department of Financial Services introduced the BitLicense, whose reporting requirements made the bitcoin payments program unworkable in Afghanistan. In effect, NYDFS killed bitcoin privacy, which in turn deprived those young women of an income.

In an episode of our “Money Reimagined” podcasts, Women’s Annex founder Francesco Rulli asked us to imagine the impact of those payments on the power dynamics of Afghanistan’s patriarchal society if the BitLicense had never come into effect. What would it have meant, as the Taliban tried to regain power in 2021, if up until that time an expanding cohort of digitally educated women had continued to receive bitcoin as it massively appreciated in value?

Read more: Crypto Privacy Protocol Monero Is Getting a Major Upgrade

Privacy for profit

But it’s not just folks avoiding oppression for whom privacy is valuable. It’s a crucial element in financial trading.

In 2015, when Wall Street institutions started exploring blockchain-based settlement and clearing systems, they refused to build on Bitcoin or other decentralized crypto protocols because, at that time, the data in those blockchains was too public. Investors don’t want the rest of the market knowing their trades lest it allow their competitors to front-run them.

More broadly, as we move into the Web3 era, with awareness growing of the costs we’ve all borne in the internet’s Web2 phase by revealing data about ourselves, the demand for privacy in our online presence will grow.

Read more: A Step-by-Step Guide to Going Private

Privacy for internet hygiene

In this week’s podcast episode, pseudonymous crypto commentator Punk 6529 talked of how, over the course of just one year, he’s seen an explosion of followers presenting as an avatar and employing a pseudonymous identity. By 6529’s reckoning, the rise of non-fungible tokens (NFTs) has fueled this privacy trend because they offer a means to prove authentic control over the image and thus to avoid the threat of impersonation that often goes with anonymity.

The bottom line is that, whether governments like it or not, demand for privacy is growing – and will perhaps even accelerate the more they try to suppress it.

But don’t hold your breath on regulators pulling back on their attack on privacy. They’re motivated to go after mixers and other methods of obfuscation by the amorphous, growing presence of rogue actors. This includes the massive hacker networks that steal money and identities and that use ransomware to hold our infrastructure hostage or state terrorists such as the North Korean hackers who prompted Treasury to go after Tornado Cash.

This could become the mother of all crypto clashes.