Unraveling the Challenges and Possibilities of Compliance in Privacy Pools
Summary:
Ameen Soleimani's Privacy Pools project aims at refining Tornado Cash, an open-source platform for anonymizing Ethereum transactions. However, the project raises concerns about the possible regulation of non-custodial crypto-asset mixers. While the concept intends to provide automated compliance at the smart contract level, questions remain about the current compliance of privacy pools and their potential to satisfy both crypto community ethos and regulatory demands. Ensuring that undesirable actors do not exploit the potentially regulated environment is a central theme of the discussions.
Earlier this year, renowned developer and entrepreneur Ameen Soleimani introduced Privacy Pools. This project is an effort to refine and transform Tornado Cash, an open-source platform for concealing Ethereum transactions, to make it more palatable to regulators. This idea, initially proposed by Ethereum co-founder Vitalik Buterin in 2022, failed to evoke a substantial response from the crypto enthusiasts initially. But, things took a turn when Buterin published an academic paper on the topic, resulting in a whirlwind of social media attention.
The merge of "blockchain privacy" with regulatory compliance" has made crypto enthusiasts uneasy, especially the ones who are doubtful if regulators would approve the use of non-custodial crypto-asset mixers- vital to the on-chain economy but vastly misunderstood.
As we progressively steer towards a digital future, zero-knowledge proofs will become mainstream and a segment of decentralized finance (DeFi) will gain benefit from automated compliance at the smart contract level. Such discussions are ignited by this paper even though it does not provide a conclusion. The question remains on how to transition from A to B.
The key discussion is whether privacy pools can really be compliant currently. Can they match the core principles of the community - mainly the part that insists on averting illicit use of tokens, as emphasized by the Pretty Good Policy for Crypto podcast recently? Further, how do we overcome the narrative, which is a major loophole in the paper?
Even if the proposed implementation is robust, users can only establish their innocence by demonstrating that their original deposit either hails from a group of supposedly legitimate sources or doesn't come from a group of unlawful sources known at present. These are called association sets and their enactment is yet to be determined by the ecosystem. Compliance is not only about OFAC’s SDN list addresses or avoiding notorious actors.
Indeed, if a protocol is hacked, or if a criminal's wallets are identified while attempting to transfer funds to new addresses, they can be added to an association set for honest users to avoid. This is simple, and the paper also suggests other construction mechanisms, like inclusion delays or zero-knowledge Know Your Customer (zkKYC) pools.
Nevertheless, illicit actors can go unnoticed for an extended period before being identified as such, making regulators apprehensive. This is because coins linked with illegal activity could come back into circulation. Conversely, in the conventional finance world, physical cash makes up a shrinking proportion of payments, and illegal funds held at banks can be quickly seized. Regulators are comfortable with the in-depth revealing that thorough KYC processes afford.
Stipulating that this suffices modern-day regulators, it is also vital to know if the crypto community is satisfied with the solution in order to drive adoption. This consideration is not only about hardcore cypherpunks but also users from tyrannical regimes and political activists in unstable democracies.
To enhance transaction privacy, it is imperative that users trust the entire ecosystem around these pools. Certainly, association sets can be entirely automated. Even so, it depends on the oracles and the public and private entities controlling these lists, who decide on who is a bad actor and who isn't, typically without a mandate.
Ameen Soleimani emphasised that the protocol "doesn’t demand a compromise on crypto ideals". Nonetheless, even honest actors attempting to prove their innocence can do so only to the extent that their jurisdictions recognize sufficiently large and relevant association sets for the proofs to work, or if designated association set providers can be relied upon.
Lastly, the initiative is well-intentioned with a versatile and potent design. However, many builders remain skeptical about its usefulness in terms of regulations. This skepticism stems mainly from developers being wary of rules, fearing imprisonment or fines in the context of vague global legal frameworks for DeFi.
Such a protocol won't instantaneously solve this issue, as it creates a regulated environment for users (and governments or lawmakers) to choose from. It is certainly a constructive proposal with praiseworthy self-regulation, but the crypto policy conversation requires more. Without it, the gap will keep growing while privacy continues to be assaulted.
Ultimately, we can only create something successful if we agree to its guidelines and if the end product meets the demands of stakeholders and customers. The corollary is that if the requirements are unacceptable, we need the whole community's support to rally behind the change - in this case, for enhanced privacy protection and privacy education.
The ball is in your court. Have you shown your support towards your national crypto advocacy groups? Are you aware of their goals? Have they done commendable work on this topic? (Coin Center, for instance, filed a lawsuit against the United States Treasury Department after it sanctioned the use of Tornado Cash last year.)
If not, it's high time you got involved. Let's lobby for a brighter future or we will never get there.
Hugo Volz Oliveira is a founding member at the New Economy Institute, a group aimed at making Portugal and Europe more crypto-friendly. Oliveira has been active in the crypto space since 2017 as the lead analyst at the London Block Exchange. He also supervised the creation of the Portuguese Federation of Associations for the Crypto Economy (FACE) and the organization of the The Reg3 Conference with the EU Crypto Initiative.
Published At
9/25/2023 11:00:01 PM
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