A New Research Paper Explores Privacy and Compliance in Blockchain
A new research paper co-authored by Ethereum co-founder Vitalik Buterin delves into the ways in which blockchains can remain both private and compliant with government regulations.
Friction Between Permissionless Networks and Government Oversight
The paper comes during a notable period of friction between the use of permissionless networks and government agencies wishing to expand their oversight of such activities. Last month, two co-founders of the EVM-compatible transaction mixing service Tornado Cash were charged by the US government.
The Proposal of Privacy Pools
The paper’s authors — Buterin, as well as Chainalysis chief scientist Jacob Illum, University of Basel professor Fabian Schär, doctoral candidate Matthias Nadler of the University of Basel, and Spankchain co-founder Ameen Soleimani — contend that good and bad actors could be distinguished through the use of a “smart contract-based privacy enhancing protocol” dubbed Privacy Pools.
Zero-Knowledge Technology for Privacy
Privacy Pools uses zero-knowledge (ZK) technology and enables users to generate a new withdrawal address that can’t be linked to previous transactions. It also lets users choose their own privacy settings — meaning they can exclude any suspicious users from their transactions. This can be achieved through Merkle roots.
Cooperative Solutions for Privacy and Regulation
The authors note that their intention is to find cooperative solutions between lawmakers, regulators, and practitioners across various fields to ensure that privacy-enhanced infrastructure can thrive in an otherwise regulated environment. They argue that the proposal is flexible and can potentially satisfy a large variety of regulatory requirements.
Inside Privacy Pools
Any crypto asset created and spent on a blockchain possesses a coin ID (or hash) associated with it. This information is stored using a Merkle tree, a data structure through which each hash is linked to another hash in a tree-like structure. Numerous transaction hashes are stored in a block, and each block is also hashed, creating a Merkle root.
In tandem with zero-knowledge tech, users can prove that their withdrawals are made through a previous deposit while only revealing information from a limited data set of their choosing. This means that honest users can prove that the origins of their funds are not directly tied to criminal activity.
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