Even though the word "crypto" in the word "cryptocurrency" sounds secretive, most cryptocurrencies are fairly open. After all, transactions on public blockchains are public knowledge, and transactions can be tracked using wallet addresses. A new generation of privacy coins, however, seeks to alter the game by employing many cutting-edge strategies.
Let's examine privacy coins in more detail, their convoluted legal position, and any potential tax repercussions to be aware of.
Privacy coins shield transaction information and wallet addresses from prying eyes, yet they have come under assault from regulators throughout the world.
- What are privacy coins and are they legal?
- Which token is a privacy coin?
- Are privacy coins the future?
- How do private cryptocurrencies work?
- What Are Privacy Coins?
On the surface, privacy coins, sometimes referred to as private coins or anonymous coins, resemble traditional cryptocurrencies. For instance, they function on open blockchains that rely on a system of unidentified validators. The wallet address, wallet balances, and transaction amounts are all concealed by privacy coins, though.
Validators link the sender, recipient, input, and output data on a public blockchain in traditional blockchains. Privacy coins, on the other hand, employ different strategies to verify transactions without revealing addresses or values. Users of privacy coins can benefit from total anonymity from prying eyes as a consequence.
The largest privacy coins by market cap include:
- Monero – Monero is the leading cryptocurrency focused on private and censorship-resistant transactions and the only cryptocurrency where every user is anonymous by default.
- Zcash – Zcash bills itself as the "HTTPS of blockchains" and the first project to implement zk-SNARKs, a novel form of zero-knowledge cryptography yielding the most robust privacy.
- Decred – Decred is an anonymous digital currency with a hybrid consensus system that supports decentralization, sustainability, and self-ruling capabilities.
- Oasis – Oasis is a leading privacy-enabled and scalable Level 1 blockchain network designed to support Web3, focusing on scalability and high-throughput transactions.
How Do Privacy Coins Work?
Various strategies are used by privacy coins to conceal wallet addresses and transaction information. Even while Zcash's zero-knowledge proofs are its most well-known method, new privacy coins are continually pushing the boundaries with fresh and cutting-edge ideas. Users therefore have several alternatives for maintaining their privacy.
Some of the most common techniques include:
- Mixers – Mixers take coins from different senders and combine them into a single transaction. After a validator mixes the coins, recipients receive them in newly created wallets. (Dash)
- ZK Proofs – Zero-knowledge proofs to prove that transactions are valid without sharing details. While the math behind these proofs is complex, they are highly-scalable solutions. (Zcash)
- Blockchains – New blockchain designs eliminate the need for addresses altogether and only look at signature data. By matching inputs and outputs, they can validate transactions. (MimbleWimble)
Several initiatives address the issue of revealing one's identity when acquiring privacy coins in addition to privacy coins. For instance, Tornado Cash enables users to transmit anonymous ETH and ERC-20 deposits. Users of TOR can conceal their IP address, making it challenging to track transactions to a particular location or machine.
Are Privacy Coins Legal?
In August 2022, the U.S. Treasury publicly sanctioned Tornado Cash, claiming that since its formation in 2019, it has assisted in the laundering of more than $7 billion. The government specifically mentioned that it assisted in the laundering of $455 million that was taken by North Korean hackers. Crypto supporters counter that endorsing open source software may set a risky precedent.
With the assistance of Coinbase and other sizable organisations, several cryptocurrency enthusiasts are suing the Treasury department in an effort to get the ruling reversed. These parties contend that penalising open source software rather than specific people or organisations sets a risky new precedent that might have repercussions for the whole IT sector.
Individual tools are simpler to attack, but several countries have cracked down on privacy currencies. Australia, New Zealand, and Japan, for instance, have all outlawed the sale of coins on exchanges. However, many privacy coins are not yet listed on popular exchanges in the United States and Europe due to "know your customer" rules.
Given their involvement in high-profile crimes and regulators' inability to trace them, privacy coins are expected to continue to come under investigation. Regulators might make it impossible to deal in these currencies by strictly implementing anti-money laundering regulations at the exchange level, even though punishing or prohibiting projects rests on shaky legal foundation.
What Are the Tax Implications?
The same tax laws and regulations apply to privacy coins as they do to traditional cryptocurrencies. The IRS specifically views all cryptocurrency holdings as "property" that is subject to capital gains taxes. When received, any income, interest, or prizes may be subject to ordinary income tax; any subsequent capital gains tax will be applied to any value increases.
Of course, the fact that privacy coins are intrinsically untraceable may cause some taxpayers to doubt the necessity of disclosing their income or capital gains. In fact, the value of the Monero privacy currency increased by more than 30% when President Biden suggested mandatory tax reporting on company transactions exceeding $10,000, indicating interest in ways to get around the new regulations.
Even if privacy coins are now untraceable, taxpayers shouldn't believe their anonymity will last indefinitely. The inability to correctly report and pay taxes might result in significant fines and penalties in addition to feeding the government's perception that privacy coins are used for unlawful activities (harming the concept's reputation).
Taxpayers may be liable for unreported cryptocurrency revenue decades after the fact since the IRS has no time limit for enforcing civil or criminal fraud penalties. In order to prevent problems, taxpayers need be sure to maintain proper records and pay their anticipated taxes - a chore that is made simpler with the right crypto tax software.
The Bottom Line
Privacy coins efficiently conceal transaction information and wallet addresses from prying eyes. Many privacy currencies are still legal for individuals to use, despite criticism from regulators. But it's important to keep in mind that they are subject to the same tax laws and regulations as traditional cryptocurrencies.
If you trade crypto assets, ZenLedger can assist you in keeping track of your holdings, combining transactions from several exchanges, and calculating your yearly capital gain or loss. Through tax loss harvesting and other strategies, you might also identify ways to reduce your tax obligations.
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