Vitalik Buterin Suggests Privacy and Financial Regulation Compatible in Co-Authored Paper

Ethereum co-founder Vitalik Buterin co-authored a paper that outlined blockchain privacy while considering financial regulation. The paper discussed privacy-enhancing methods like “Privacy Pools” to safeguard transaction privacy while maintaining compliance.

The documents also circle Tornado Cash, which the US government sanctioned for its alleged engagement in money laundering.

Privacy Pools With Compliance

The paper titled “Blockchain Privacy and Regulatory Compliance:Towards a Practical Equilibrium” introduces Privacy Pools. These protocols conceal transaction history to provide privacy. However, it differs from mixers like Tornado Cash, which faces sanctions in the US.

The document notes,

“Tornado Cash has also been used by various bad actors. Deposit data suggests that hacker groups have moved funds from illicit sources through the protocol.”

BeInCrypto previously highlighted that Privacy Pools look to address the major flaws in Tornado Cash. The latter has since been associated with several illicit transfers. These reportedly include helping North Korean hackers to steal and withdraw millions.

North Korean-Linked Hacks and Value. Source: Chainalysis

However, Privacy Pools allows users to provide information on withdrawals with membership and exclusion proofs based on information provided in the paper. The proofs provide specific transaction details to ensure compliance with the rules.

Unlike Tornado Cash, Privacy Pools can be publicly published and are open source.

Read more: TornadoCash: Everything You Need To Know

Ameen Soleimani, one of the early contributors to Tornado Cash, took to Twitter to note some of the key highlights of the protocol. The influencer tweeted,

“With Privacy Pools, users can publish zero-knowledge proofs that their withdrawal originated from an “association set” that excludes known illicit deposits.”

The document also describes the cryptography of “nullifiers” that can obscure coin transfers. Additionally, the paper states that Zero-Knowledge Proof (ZK-SNARK) contains inputs to validate transactions by revealing the nullifiers. This means users can maintain their financial privacy while proving their funds’ origin.

Read more: What Is Metadata Privacy And Why Does It Matter?

Why Is Privacy Not Compatible With Law?

Soleimani noted,

“We quickly realized that Privacy Pools provides new compliance tools for regulators beyond what they covered in their paper on Tornado Cash and based their initial policy recommendations on.”

The paper suggests that privacy and financial regulation can coexist. This means users can keep their financial activities private while complying with the law. It presents a key idea that users of a privacy-enhancing system should be able to prove specific transactions without revealing all their financial details.

For instance, they can confirm that their funds aren’t linked to illegal activities or that they belong to a certain group.

How Privacy Pools Function. Source. Messari Research via Ryan Selkis' Twitter
How Privacy Pools Function. Source. Messari Research via Ryan Selkis’ Twitter

The authors also start a conversation between different groups, including practitioners, academics, policymakers, and regulators, to develop privacy-enhancing infrastructure that works within regulatory frameworks.

The proposal aims to create a “separating equilibrium” where honest users can prove their compliance with regulatory requirements. However, it calls for Dishonest users to find it challenging to provide such proof.

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