The co-creator of Ethereum (ETH) is detailing a mechanism by which dishonest crypto users can be rooted out of crypto mixing protocols.
In a new paper, Ethereum co-creator Vitalik Buterin and four additional authors detail how privacy pools can be useful in weeding out unscrupulous crypto traders.
A privacy pool is a smart contract-based privacy project that lets users generate new ETH addresses not associated with their prior transactions.
As stated in the abstract of the paper,
“The core idea of the proposal is to allow users to publish a zero-knowledge proof, demonstrating that their funds (do not) originate from (un)lawful sources without publicly revealing their entire transaction graph. This is achieved by proving membership in custom association sets that satisfy certain properties, required by regulation or social consensus.”
In a lengthy thread, one of the co-authors of the paper, Ameen Soleimani of Privacy Pools, further explains how the protocol works and how it could help the issues experienced by users of sanctioned crypto mixer Tornado Cash, which was deemed a national security threat in 2022 and banned in the US.
“Privacy Pools is an open source project attempting to fix the most important flaw in Tornado Cash: Tornado Cash users were not able to provably dissociate from illicit funds – except by revealing their entire transaction history – which only a few did…
With Privacy Pools, users can publish zero-knowledge proofs that their withdrawal originated from an ‘association set’ that excludes known illicit deposits. In theory, this allows users to prove regulatory compliance and still maintain privacy while using public blockchains.”
Soleimani says he plans on meeting with US regulators, such as the Office of Foreign Assets Control (OFAC) and and the Financial Crimes Enforcement Network (FinCEN), to see how the pools can be used to help bolster national security and combat money laundering.
The paper concludes that privacy and regulation may be compatible despite generally being perceived as contradictory.
“For instance, suppose users can demonstrate that their funds have no ties to deposits from known illicit sources, or prove that the funds are part of a specific set of deposits, without revealing any further information.
Such a setup can generate a separating equilibrium, where honest users are strongly incentivized to prove membership in a given, compliant association set, while still enjoying privacy within that set. Conversely, for dishonest users, it is impossible to provide such a proof.”
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