In a groundbreaking research paper, Ethereum co-founder Vitalik Buterin delves into the world of privacy pool systems and their potential to harmonize financial regulations with blockchain technology. The paper introduces a novel approach that utilizes zero-knowledge proofs to address privacy concerns while ensuring compliance. Buterin, along with co-authors Jacob Illum, Matthias Nadler, Fabian Schar, and Ameen Soleimani, aims to strike a balance between privacy and regulatory requirements.
The document begins by examining the Tornado Cash protocol, a popular privacy-enhancing tool that allows users to transact cryptocurrencies without revealing their identity. However, recent criminal charges and US OFAC sanctions against its founders highlighted a significant drawback: the inability for legitimate users to dissociate from illicit activities attracted by the protocol.
The critical issue with Tornado Cash was essentially that legitimate users had limited options to dissociate from the criminal activity the protocol attracted
Read the paper authored by Jacob Illum, Matthias Nadler, Fabian Schar and Ameen Soleimani.
Buterin’s proposal suggests a way forward by introducing the concept of association sets within privacy pool protocols. Users can now publicly prove the source of their funds while protecting their privacy. By proving membership in custom association sets, users can demonstrate that their funds originate from lawful sources without disclosing their entire transaction history.
The core idea of the proposal is to allow users to publish a zero-knowledge proof, demonstrating that their funds (do not) originate from known (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 hypothetical scenario, Buterin illustrates the concept: “Suppose we have five users: Alice, Bob, Carl, David, and Eve. The first four are honest users who value their privacy, while Eve has a questionable background. When users want to withdraw funds, they specify their association set, incentivizing them to include more users for privacy. However, they exclude Eve to prevent suspicion from merchants or exchanges.”
Users are encouraged to expand their association sets in order to protect their privacy in the example since they can choose which association set to belong to when they wish to withdraw money. However, the users do not include Eve in their association set in order to prevent their funds from being viewed as suspicious by merchants or exchanges. Eve will be required to build an association set that is equal to the set of all five deposits because she is unable to omit her own deposit.
[W]e assume that Alice, Bob, Carl and David include all other ‘good’ deposits in their respective association sets and exclude deposit 5, that originates from a known illicit source. Eve, on the other hand, cannot create a proof that disassociates her withdrawal from her own deposit
The authors emphasize that this system doesn’t rely on altruism but rather provides users with a clear incentive to prove their disassociation, aligning privacy with regulatory compliance.
Furthermore, Buterin’s vision extends beyond privacy pools. Recently, at the Korea Blockchain Week conference, he stressed the importance of addressing node centralization in Ethereum, highlighting the need for decentralization principles. He believes that stateless clients could play a role in achieving this goal, potentially involving mobile devices in the network’s decentralization and scalability.
In a separate conversation, Buterin praised the broader cryptocurrency ecosystem’s progress, emphasizing the significance of scalability improvements and innovative standards like Ordinals and the BRC-20 token.
As global regulations continue to evolve, users seek to safeguard their privacy, and blockchain technology matures, the role of zero-knowledge proofs in achieving the delicate balance between privacy and compliance is poised to grow. With Ethereum leading the way in implementing such solutions, the crypto community eagerly awaits the next evolution in blockchain technology.
Other things Vitalik said recently highlight his commitment to preserving Ethereum’s decentralization and fostering a culture of progress within the cryptocurrency space, reinforcing the belief that blockchain can adapt to meet evolving needs while complying with regulations.