In 2017, cryptocurrencies simply couldn't be stopped. For the year, the aggregate value of virtual currencies galloped higher by more than 3,300%, or almost $600 billion in market cap in nominal terms.
But this year has been markedly different. Recently, digital currencies hit their lowest combined market cap since around Thanksgiving, and momentum surrounding blockchain technology -- the digital, distributed, and decentralized ledger that underlies cryptocurrencies and is responsible for recording all transactions without the need for a bank -- has waned. In fact, in less than three months' time, we've witnessed the aggregate crypto market cap lose close to 70% of its value from peak to trough.
The carnage has been felt almost across the board. With the exception of a few tokens, such as Binance Coin, the official token of the Binance cryptocurrency exchange, which has benefited from transaction fees as trading volume and interest in virtual currencies has increased, most everything has dropped. But perhaps no trend has gone colder in recent months, relative to where it was in say December 2017, than privacy coins (also referred to as black coins), like Monero and Dash.
The push toward anonymity
One of the greatest lures of cryptocurrency ownership and investing, at least in the early days, was the perception of anonymity. Because virtual tokens aren't backed by any government agency, and these transactions aren't processed through traditional banking channels, there was the belief by crypto users that their transactions were anonymous. But, we also learned in late November that this isn't necessarily the case.
In November, the Internal Revenue Service (IRS) won a court case against cryptocurrency exchange giant Coinbase that required the exchange to turn over information on 14,355 users who, between 2013 and 2015, had conducted $20,000 or more in trading activity on bitcoin. While the move by the IRS was made to go after tax-evaders -- only 800 to 900 tax filings annually between 2013 and 2015 listed bitcoin capital gains and losses -- the broader thesis here was that cryptocurrency transactions weren't as anonymous as once believed. A blockchain analysis could, with quite a few virtual currencies, be traced back to a sender and receiver of funds.
Thus entered privacy coins into the picture. These were virtual tokens with a sole purpose: obfuscate the sender and receiver of funds, as well as the amount being sent. They were an evolution of existing cryptocurrencies with an added emphasis on anonymity.
Monero is probably the best known of all privacy coins. Using its open-source protocol known as CryptoNote, ring signatures obfuscate the actual sender of XMR (Monero's token). Think of ring signatures as a bank account with multiple signers, without knowing which of those signers actually sent funds. Once a transmittance has been made, a one-time spend key, known as a stealth address, is generated, allowing only the recipient to detect and spend those funds. For crypto investors who seek anonymity, privacy coins like Monero are the pinnacle, which is why they finished 2017 so strongly.
Are privacy coins going the way of the dodo?
Unfortunately, Monero, Dash, and the rest of the privacy coins have been a disaster since January, and it all has to do with an increasing effort in key markets to improve transparency.
In late January, South Korean regulators shook cryptocurrency investors to the core -- South Korea has been a key player in the rise of virtual currency valuations -- when it announced plans to beef up transparency involving crypto trading. In particular, the government would require banks to verify the identities of accountholders when linking their bank accounts to cryptocurrency exchanges. Without this verification, no new funds could be added after January. Some investors initially viewed this action as a crackdown on virtual currencies, but the South Korean government suggested just the opposite. It was merely a means of moving toward a more legitimate investment platform.
While not as defining, the U.S. has also made moves to improve transparency. As noted, the IRS in November won a court case that'll give it access to over 14,300 users, some of whom may have knowingly evaded paying tax on their virtual currency profits. But the recently passed Tax Cuts and Jobs Act does its part, too. It eliminated "like-kind exchanges" with regard to cryptocurrencies. This loophole had allowed investors in previous years to sell one virtual token and buy another, all while avoiding having to pay capital gains since it fell under the "like-kind exchange" umbrella. That's no longer the case as of Jan. 1, 2018, meaning all crypto sales, even in instances where tokens are being used to purchase goods and services, need to be treated as an investable capital gain or loss.
As this push toward transparency gains steam, it's becoming harder to see a path forward for privacy coins, at least on a broad-scale basis. Though their obfuscating protocols might appeal to investors in countries where cryptocurrencies are banned or seriously frowned upon, as well as to the criminal community, they don't appear to have much of a future in South Korea or the U.S., which have been two crucial markets for the crypto community in terms of total trading volume and cash inflow.
Though I'm not ready to call the privacy coin movement dead, it's certainly skating on thin ice. And while I'd suggest avoiding cryptocurrency investing altogether, I'd be especially wary of privacy coins.