Privacy coins are cryptocurrencies that focus heavily on security, keeping user transactions anonymous. That's long been one of cryptocurrency's biggest appeals, but their focus on anonymity has also given privacy coins something of a... reputation. But privacy coins' shady image may be blinding investors to a great opportunity.

These hard-to-track coins are often used in illegal activities online. The US Treasury even established a bounty program on behalf of the Internal Revenue Service, offering up to $625,000 to people who could crack and trace transactions for the privacy coin Monero (XMR 1.89%) and certain other cryptocurrency transactions. Financing unlawful actions obviously isn't the only use for these coins, and it's not even the primary reason that many cryptocurrency enthusiasts like them. But for some cautious investors, that might not matter.

A person conceals their face with a sign covered in question marks.

Image source: Getty Images.

The appeal of privacy coins

Criminals like privacy coins because they're good at what they claim to provide. As of 2018, Monero was used in approximately 44% of ransomware attacks thanks to the anonymity it provided, dwarfing the use of more popular coins such as Bitcoin (which only made up 10%) and Ethereum (11%).

Its inherent anonymity has also made it popular as a payment method on the Dark Web, and while it's not as popular as Bitcoin, it is now accepted as an option on the majority of popular dark marketplaces. Mining scripts embedded in websites are also turning to privacy coins like Monero. One popular script that was discovered within the last few years was mining Moreno and sending it to a server in North Korea.

This doesn't mean that criminal activity is the only appeal of privacy coins, of course. Unlike Bitcoin, coins like Monero do not expose details of a user's cryptocurrency wallet while completing transactions, nor record potentially identifying details in the blockchain ledger. While this doesn't mean that exploits could never be used to compromise Monero transactions, it still remains significantly more private and secure than its more popular brethren.

As a result, Monero is increasingly being used as an intermediary for Bitcoin transactions. Bitcoin holders buy Monero and use that currency to settle transactions in order to complete private money transfers without having to expose their public wallet address. The increased acceptance of privacy coins, and their role in increasing the anonymity of more popular coins, are helping to fuel their growing market.

Growth in the privacy coin market

Monero has shown upward mobility since 2019 despite its use in illegal activity. The token's price has roughly doubled in the past year, even after the IRS announced its bounty. Monero's increasing popularity has pushed it into the top 20 cryptocurrencies by total market value. It has enjoyed significant development support as well, with the third-largest developer community among all cryptocurrencies, trailing only Bitcoin and Ethereum.

Smaller privacy coins have almost universally enjoyed similar growth trajectories. Zcash (ZEC 9.71%) has seen its price nearly triple in the last year, while Dash (DASH 4.45%) more than doubled during that same period. Some of this growth may be driven by investors looking to cash in on the popularity of Monero by targeting similar coins. But these gains have continued even after Monero and some other privacy coins were delisted from multiple exchanges in an attempt to curtail illegal activity. That suggests the coins are growing primarily because more people are using them more often.

Risks and rewards

A major scandal involving Monero or some other privacy coin would cause prices to crash but that risk seems relatively low. Monero is already used for illicit transactions, payments for ransomware, and other scandalous activities -- yet, its value continues to rise. Even the discovery of a bug earlier this year, which could weaken Monero's privacy in certain situations, hasn't dampened enthusiasm for the coin (though it did get the developer community in gear to patch the issue).

Smaller coins may be more likely to be affected by scandal because they aren't as widely used yet. But if Monero can continue growing despite its issues, it's reasonable to assume that other coins with solid security benefits could weather similar storms as well.

Private investments

Because of their nature, Monero, Zcash, Dash, and other privacy coins are always going to appeal to certain less-than-wholesome elements online. But the legitimate need for a platform for private and secure online transactions will only grow as tech companies continue pushing their various online interaction platforms. People increasingly want ways to send and receive payments without the fear that their transaction histories are being tracked or that financial information may be compromised -- especially since 2021 had seen 17% more reported data breaches just by the end of October than were reported in all of 2020. Cryptocurrency users are also looking for ways to protect themselves from crimes such as the $600 million Bitcoin heist that occurred when Poly Network was hacked earlier this year.

Smart cryptocurrency investors will realize that you shouldn't judge a good investment solely by what some people choose to do with it. Privacy coins that feature highly active development communities and growing acceptance among online retailers or cryptocurrency debit cards -- which helps them serve as proxies for less-secure coins -- could become the top picks as the sector continues to heat up.