The unique strength of blockchain and cryptocurrency can also be considered as its weakness. Cryptocurrency users gain unparalleled confidentiality of financial transactions thanks to a decentralized transaction system. However, governments demand transparency in financial transactions for legal reasons. This creates a paradox. People are less likely to use financial instruments if they disclose their money to the world. On the contrary, there are a number of regulations that require financial institutions to fight terrorism and money laundering, which is a major concern for many authorities.
At the heart of the problem is that most public blockchains require the consent of all participants to verify transactions. How can both parties – individual users and authorities – achieve their conflicting goals when they are completely opposite?
A potential solution to this problem includes balancing the concerns between users’ privacy and the centralized supervision that the authorities need to ensure compliance with regulations such as money laundering, customer awareness and terrorist financing. The implementation of cryptocurrency procedures, together with government oversight measures, creates a delicate balance where cryptocurrency assets remain secret, but are subject to financing laws worldwide.
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Fight against terrorism and money laundering
The need for the authorities to control cryptocurrency transactions to combat terrorism and money laundering is crucial for public security, especially since the two are intertwined. Money laundering can be used to finance terrorist activities that, like everything else, require funding, even if they are not related to money laundering. Cross-policy cash flow research on popular cryptocurrencies such as Bitcoin (BTC), Ether (ETH) and others can provide invaluable information to prevent these crimes. Regulators must at least know who pays whom and why.
However, the nature of cryptocurrency makes it easy to hide these and other transactions. Maybe bitcoin can be tracked using modern tools, but some transactions are completely traceable with other cryptocurrencies. These legitimate concerns partly explain the creation of organizations such as the Financial Action Task Force on Money Laundering, which exists to combat money laundering and terrorist financing, and whose efforts will greatly benefit from improving the transparency of cryptocurrency transactions.
On the subject: the Minister’s perspective on what regulators expect from the industry
Confidentiality means something
In many ways, concerns about public privacy concerns regarding the use of cryptocurrencies run counter to the clarity that the authorities need to combat money laundering and the fight against terrorism. People just want to keep their business secret with cryptocurrencies, as they do with traditional currency transactions. However, transaction verification features in public blockchain networks may disclose this information and violate users’ financial privacy.
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The first element of a solution that ensures consumer privacy along with government oversight is to address this issue. There are hidden transaction features, some of which are used by Monero (XMR) or Zcash (ZEC) cryptocurrencies, which mask the amount of a transaction and its participants while being verified to blockchain. These cryptocurrencies provide measures to prevent people from knowing the origin, destination and quantity of a particular transaction. These methods eliminate many concerns for the privacy of cryptocurrency holders.
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By combining these privacy practices with the following ideas for monitoring cryptocurrencies, the authorities can track activities to combat terrorism and money laundering. For example, suppose it is a cryptocurrency backed by an organization of a limited number of banks. The first thing users need to do is join these institutions, just like any other organization, which provides an initial level of understanding of cryptocurrency behavior while supporting mandates such as KYC. Then, after users have transferred transactions to others registered in that organization, they must provide the details to a bank member to prove it. This obligation can be imposed on the reseller by means of encryption, so that auditors can verify that the information was correct.