Vitalik Buterin, one of the co-founders of Ethereum, has recently published a research paper that delves into the intriguing realm of financial privacy in transactions. But what’s particularly interesting is his proposal to combine this financial privacy with regulation through the use of zero-knowledge proofs.
These privacy pool systems essentially allow users to prove that their money is not tainted by any illicit sources. They do this by employing zero-knowledge-proof technology, which allows them to demonstrate their financial separation from any potentially shady dealings.
The research paper starts by discussing an existing privacy-enhancing protocol called Tornado Cash. This protocol has been widely used to enable users to deposit and withdraw cryptocurrencies without leaving any traces that could identify their addresses. However, there’s a catch: the founders of Tornado Cash recently faced legal issues in the United States due to its misuse by malicious actors.
The paper highlights a significant drawback of Tornado Cash, legitimate users struggled to distance themselves from the criminal activities associated with the protocol.
To address this issue, the paper proposes an extension of Tornado Cash’s approach. This extension would allow users to publicly confirm the legitimacy of their funds on the blockchain. It achieves this through membership proofs and exclusion proofs.
The central idea behind this proposal is to strike a balance between honest and dishonest protocol users, potentially setting the stage for on-chain financial compliance in the future. The key innovation is that users can publish a zero-knowledge proof confirming the origin of their funds from either lawful or unlawful sources, all without revealing their complete transaction history.
Users can do this by proving their membership in customized association sets that adhere to specific properties required by regulations or societal consensus.
Within these privacy pools, users can exclude themselves from anonymity groups that contain addresses tied to illegal activities using zero-knowledge proofs. Unlike merely proving that a withdrawal is linked to a previous deposit, this approach concentrates on proving membership in a more precisely defined association set.
This association set can encompass various scenarios, such as all past deposits, only the user’s deposits, or anything in between. To simplify, the system doesn’t directly demonstrate that the association set is a subset of prior deposits; instead, it mandates users to provide zero-knowledge proofs for two Merkle branches.
The research paper also highlights several other potential applications for zero-knowledge proofs. These include demonstrating that one’s funds have no connections to illicit sources or proving that funds originate from a specific set of deposits without revealing further details.
In many instances, privacy and regulatory compliance are perceived as opposing goals. However, the paper argues that this doesn’t have to be the case. With the right privacy-enhancing protocols, users can prove specific properties about the origin of their funds while still maintaining their privacy.
In conclusion, the paper notes that zero-knowledge solutions are gaining prominence, particularly within the Ethereum network. It predicts that scaling ZK-proof solutions will experience significant growth in the coming year as global regulations evolve and users increasingly seek to safeguard their privacy.