The core principles of cryptocurrency were based on financial independence, decentralization and anonymity. With regulations being the key to mass adoption, however, the privacy aspect of the crypto market seems to be in jeopardy.

In 2022, even though no particular country has come up with a universal regulatory outline that governs the whole crypto market, most countries have introduced some form of legislation to govern a few aspects of the crypto market such as trading and financial services.

While different countries have set different rules and regulations in accordance with their existing financial laws, a common theme has been the strict implementation of Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations.

A majority of crypto exchanges operating with a license obtained from the government body or government-affiliated bodies have discouraged any form of anonymous transactions. Even in countries where there is no particular law on privacy coins, there is a ban on private transactions over a certain threshold.

The governments of the United States and the United Kingdom have also demanded regulatory action against the use of coin mixing tools, a service used to obscure the origin of a transaction by mixing it with multiple other transactions.

Coinjoin, a popular crypto mixing tool, recently announced they would block illicit transactions amid-regulatory heat.

Related: Crypto mixers’ relevance wanes as regulators take aim

The recent delisting of Litecoin (LTC) by several crypto exchanges in South Korea owing to its recent privacy-focused MimbleWimble upgrade is another example of how the privacy aspect of the cryptocurrency is the first to fall on the road to regulatory acceptance. Apart from South Korean exchanges delisting LTC, many global exchanges including Binance and Gate.IO also refused to support transactions using the MimbleWimble upgrade.

Most regulations focus on making cryptocurrencies more transparent so that consumers and businesses feel at ease with them. This may be good news for institutional and corporate investors, but it could be a blow for privacy-focused coins.

At a time when regulatory oversight is at its highest, there is a special threat to privacy coins such as Monero (XMR) and ZCash (ZEC), which are already banned on several leading exchanges. However, experts believe that despite the ongoing case against privacy coins, people will continue to use them.

Privacy tokens are a red flag for many regulators, who often prefer that blockchain transactions are auditable, verifiable and take place on a public chain.

Under regulatory scrutiny around the world

Privacy coins obscure the key identifiers of transactions such as the address of the sender or receiver, a feature that regulators believe could be misused by miscreants. Even some nations like Japan, which was once seen as the leading country in terms of progressive crypto regulations, decided to do away with privacy coins.

Japan banned the use of privacy-focused cryptocurrencies in 2018, after which several registered crypto exchanges in the country delisted privacy coins from their platform. Similarly, South Korea has not just banned privacy coins, but any form of private transactions is prohibited on Korean crypto exchanges.

In the United States, privacy coins remain legal. However, the Secret Service recommended that Congress regulate privacy-enhanced cryptocurrencies.

In August 2020, Australian regulators forced many exchanges to delist privacy coins. The Financial Action Task Force (FATF) has similarly listed the use of privacy coins as a potential red flag for money laundering through virtual assets.

Some cryptocurrency exchanges have also stopped offering privacy coins as a result of AML guidance. In January 2021, Bittrex, the eighth largest cryptocurrency exchange by volume, announced that it would drop Monero and Zcash from its platform. Kraken, the fourth largest exchange, delisted Monero in the United Kingdom in November 2021 following guidance from the United Kingdom’s financial markets regulator.

Ankit Verma, chief investment officer at crypto investment platform Mudrex, told Cointelegraph:

“While some exchanges periodically prohibit trading privacy coins, most of the largest privacy coins are currently available for trading across major exchanges in different jurisdictions. Yet, the institutional skepticism around the adoption of privacy coins persists. It is difficult to predict the usage of privacy coins on a wider scale primarily because of the strict enforcement of KYC and AML guidelines. Our belief is the absence of institutional affinity for privacy coins combined with the fact they are unregulated further dampens the possibility of widespread adoption of privacy coins.”

Regulatory pressure has mounted to such a level where even privacy features of particular cryptocurrencies come under scrutiny, even if the crypto itself is not solely focused on privacy. Thus, experts believe the real winners will be those who combine the best of privacy and regulatory compliance. 

Fennie Wang, CEO at Humanity Cash — a community-based currency development platform — told Cointelegraph:

“The winners will be protocols that balance between user privacy and regulatory compliance using a combination of cryptographic techniques and sound policy translation. Decentralized identity primitives alongside zero-knowledge Proofs, homomorphic encryption and multi-party computation will be central to this equation.”

Can privacy coins survive the regulatory onslaught?

Privacy coins remain a gray area in several countries where they are not banned but governments have discouraged their use.

Chris Kline, chief operating officer at Bitcoin IRA — a crypto retirement plan provider — believes privacy coins can co-exist despite the current regulatory downturn. She explained:

“Privacy coins can co-exist in a regulatory environment. This coexistence will take place alongside new rules and challenges as the CFTC takes the lead on standards ahead.”

Many other experts believe that, while privacy coins will find it hard to get regulatory approval, regulators will become more sophisticated toward privacy coins and bring them under their regulatory purview.

Nikos Kostopoulos, a blockchain adviser at European Union IT infrastructure firm NetCompany, told Cointelegraph:

“While it is foreseen that privacy coins might not have a position in regulated cryptocurrency exchanges, the privacy coins will not be evaporated from the market cap, but rather will find audiences and venues where privacy is fundamental while regulators will become more sophisticated towards their approach to privacy coins — for example with imposed KYC/AML once there is a transaction with fiat currencies or cryptocurrencies.”

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Privacy is still a key concern for many in the crypto community, and this concern is amplified when it comes to sensitive information such as financial transactions. This is why privacy coins are so important for preserving and securing users’ interests. They ensure that sensitive user data is not accessible to just anybody and that transactions are conducted privately. Some privacy coins such as Zcash and Dash (DASH) let users choose whether or not to encrypt their transactions, giving them complete control over their data.

Multiple reports have shown that less than 1% of crypto transactions account for criminal activity and cash still remains the currency of convenience for criminals. Given all these positives of privacy coins, declaring a full ban on them might cause a threat to user privacy and, ultimately, the underlying technology.