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Privacy Issues In Decentralized Finance and How Zero-Knowledge Proofs Can Help

by Awa Yun Sin, Co-Founder of Anoma, a suite of protocols enabling self-sovereign coordination

It’s no secret that the current stage of the internet, or Web2, has had its fair share of privacy issues. However from a financial perspective, privacy guarantees for end-users are pretty good. Your online bank statement and cash transfer records are private documents that are available to only you, the bank, and select government authorities. Importantly, your information isn’t publicly available to anyone who wants to take a look.

We are currently in a liminal stage on the web however. A new era of finance is starting. The technologies underpinning the next iteration of the internet — Web3 — such as blockchain, are enabling novel ways for people to interact with each other and conduct business. Despite the ongoing hype about Web3, there are still serious issues that need to be addressed, especially when it comes to decentralized finance (DeFi).

Most importantly, Web3 technology doesn’t provide any privacy guarantees to end-users. Blockchain has some fundamental privacy problems by virtue of its design. Its decentralized nature means that multiple nodes process on-chain transactions, meaning multiple nodes also have access to that on-chain data. In the case of cryptocurrencies, every transaction can be traced back to its origins. A user’s entire financial history when stored on-chain is completely transparent to anyone that bothers to look for it.

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For cryptocurrencies to be taken seriously as viable options for conducting financial transactions at scale globally, people need to be assured that their private information remains safe and secure. From companies’ perspectives, they need to know that their competitors can’t track where they’re buying their goods from and at what price. From a users’ perspective they need to be sure that their private financial information is not displayed for anyone technologically adept enough to find it.

In order for modern financial systems and applications to be built on Web3 technologies they need to incorporate Zero-Knowledge Proof (ZKP) systems that allow information to remain private. These are encryption systems that allow one entity to prove the truth of specific information to another party or verifier without disclosing any additional information. They also mean that users can selectively reveal parts of their information to selected third parties, such as the tax authorities, whilst keeping it concealed for others.

ZKPs provide essential flexibility and choice for users, allowing them to control how and where they share their information. The applications for new forms of financial coordination are endless. For example with ZPKs a user can provide the details necessary to obtain a loan, without revealing their current salary or a company could fulfill their KYC requirements without revealing their customer’s private data.

Embedding privacy into decentralized payments networks to protect against non-consensual usage of sensitive data is essential. ZKP’s combined with blockchain technology have the power to provide users with a powerful mix of immutability and security, restoring control in economic exchange and safeguarding financial information that could otherwise be exploited.

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