Headline: What are the privacy concerns when considering cryptocurrency?

Body:  Privacy concerns are paramount in the minds of many when you ask about cryptocurrency.   It is true: There is always a tradeoff between security and access.  I work for the government, and our major database is DOS-based.   When I asked my buddy in the deskside group, he sighed and noted that the government was cheap.  Then he shrugged and said that the DOS it is based upon is very secure.  (I think there is a very good reason: Most hackers are under the age of 30, and most of them haven’t even HEARD of DOS.)  But all jokes aside, my deskside guy is pretty good, so perhaps it might be useful to delve into the privacy concerns regarding cryptocurrency.

Is this really a big deal?

Yes.  In 2022 alone, the crypto markets were worth more than $2 Trillion.  Ever thrown a crust of bread up in the air at a beach?  Just how long was it before several dozen seagulls materialized?   If it’s more than 30 seconds, I’d be very surprised.  Online hackers and fraudsters are just like these aerial rats (sorry  to the membership of SOS, Save Our Seagulls), and will materialize in even great numbers even faster when there are Trillions of dollars involved.  That’s a lot of bread.

Why are there privacy concerns?

We already spoke of the tradeoff of security and access.  More to the point, there are slowly, being added regulations with which these cryptocurrency firms have to comply.  One such set of requirements is the Know Your Client (KYC) requirements where they collect a fairly broad array of data about the participants.   Well, in a bid to speed up the transaction time, sometimes there are compromises made to the securing of the customer data.  This is the crux of the concern.

What is de-anonymization of data?

This means that bad actors are trying to re-assemble different bits of publicly available data, and ting this to a single individual or group.  Let’s say, for fun, that you go to to look at Tik Tok on a regular basis.  Even if signed on as an anonymous person, the algorithm will quickly lean that I like dog videos a lot, especially the dog grooming videos (the best ones are the ones with the Huskies who are howling the whole time and blowing a coat.)  The algorithm might look at this and other data and conclude (wrongly) that I own a dog and would likely react positively to ads for dog-related products.  While I am a dog fan, owning one is fairly out of the question.  But the point remains that they pretty accurately described my behavior 

How De-Anonymization Works and how is it used?

Data miners can retrieve some information from each available data set they have access to, and some publicly available data (e.g. Census data)  to put together a person’s identity or transaction. For example, a data miner could retrieve a data set shared by a telecommunications company, a social media site, an e-commerce platform, and a publicly available census result to determine the name and frequent activities of a user.  We might all expect this activity to be entirely illegal, but, there are cases where it is not.  For instance, the FBI used de-anonmization tools and techniques to figure out who was behind Silk Road, and law enforcement agencies regularly track down child predators using similar tools.  Remember, no matter how good you think your privacy is, de-anonymization is always possible, given budget and equipment.

So, what are they doing to improve privacy?

In short, these cryptocurrency firms are innovating.   Two of the biggest improvements were the Lightning Network and Taproot.    The Lightning Network  is a much faster Layer 2 payment protocol (I think this is related to the sidechains post I had put together previously. )  Taproot is a program that associates several signatures together to make substantiation of transactions faster. 

I’ll See You in Court!!

This is the sign off for one of my favorite podcasts, Legal Eagle.  But, it is appropriate here too, because a group of 6 plaintiffs are taking the Treasury Department to court over their application of regulation.  In short, there was a service called Tornado Cash that allowed users to deposit cryptocurrency to one address and then withdraw the same funds from a different address.   The Treasury Department asserts that agents from North Korea and other places were using this functionality to launder money, and thus shut down this service.     The plaintiffs responded that there are legitimate reasons for doing this,   One person anonymously donated to support Ukraine, and another was using the anonymity to secure his private assets as he ran his Ethereum staking business.  Further, plaintiffs are saying that the Department exceeded its authority, granted by Congress.  The outcome should be interesting.

The Verdict

Anytime that there is a vast pool of data (and a good amount of money) floating around in the same place, you can rest assured that there are hackers nearby, preparing to try and exploit any security weaknesses that they can find.  But, the law enforcement angle makes this puzzle even more complicated.  Not too long ago, there was a mass shooting in California, and the FBI requested that Apple “crack” the phone so that e-mails can be read, and pre-meditation of this horrific act can be asserted.  Further, they asked Apple to program in a “back door” to their phones, such that law enforcement agencies could do this activity more easily in the future.   Apple said, no and the FBI countered with something like, “but we need it to keep the American people safe from terrorists.”   I am not making light of the seriousness of this debate.   I just think that we need to have the conversation as a country.






Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

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