Opinion: Why the Confidential ERC-20 Standard Needs ZK

The recent news that the infamous case against crypto mixer Tornado Cash has been overturned by the US Court of Appeals is a breath of fresh air for privacy advocates. For the first time since August 2022, it feels like anyone who believes that privacy is a human right now has a fighting chance to build a future that adheres to that principle once again.

But while this win may point to a friendlier landscape in the U.S., tensions between privacy and regulatory control continue to boil under the surface. Over recent months, privacy coins like Monero and Zcash have been delisted from crypto exchanges across Europe. The shock of the Tornado Cash sanctions – and its developer Alexey Pertsev being thrown in jail for even daring to build a privacy-focused crypto service – is also fresh in everyone’s minds despite this recent victory. In short, crypto privacy remains on shaky ground.

Circle’s Privacy Solution

Against this background, Circle’s recently announced plan to launch a new, confidential version of the ERC-20 token in partnership with Inco Network, was particularly interesting to me. Why would a crypto firm widely considered by many in the industry to be a proxy for the U.S. government choose to launch a privacy-focused token standard? Surely, even the new Trump administration wouldn’t want to relinquish quite so much control over the digital asset market, and besides, the news came out before his election win was announced.

So I looked under the hood, and while Circle’s recognition of the need for privacy-focused solutions is commendable, this new ERC-20 token doesn’t offer the level of privacy we have learned to expect in the decentralized finance ecosystem. Rather, it’s a token standard that can facilitate “confidential” salary payments, peer-to-peer transfers, vendor payments, and similar commercial use cases where traditional financial institutions are involved—and, crucially, in a manner compliant with all the key regulations.

However, this solution won’t protect your rights if you suddenly become subject to any form of regulatory restriction, for any reason. In that sense, it’s a lot like the EU’s proposals for the digital euro. It’s a sort of “privacy-enhancing” option that conceals the amounts being sent, but keeps the wallet addresses publicly visible. And there’s little to no guarantee that the authorities wouldn’t get their hands on this hidden, confidential data as soon as any questions arise – just like with the digital euro.

Looking Under the Hood

According to the announcement, Circle plans to use homomorphic encryption for this new confidential token standard. It’s a form of encryption that means computations can be performed on encrypted data, without decrypting it. But from our point of view as a decentralized web3 domain name provider, Circle is only going half the way with this method – obscuring transaction amounts while keeping sender and receiver addresses visible. This method also relies on delegated viewing, so authorities will be able to access full transaction details.

The main question for me is: why is Circle not resorting to zero-knowledge proofs for this solution? This is a method that can validate transactions without revealing any of the underlying sensitive data at all. It simply requires the prover to perform a mathematical operation to prove their knowledge of certain data, like a password or private key, without needing to show this data to the verifier.

For true privacy, zero-knowledge proofs are a groundbreaking solution, and they are already being widely used by decentralized projects like Zcash, Aztec Protocol, or Polygon Zero. As such, Circle may struggle to attract interest in its new ERC-20 standard from diehard DeFi enthusiasts.

That isn’t to say that there’s no place for Circle’s new solution in the wider ecosystem. Indeed, even as Tornado Cash is celebrating its legal win, other privacy-focused crypto products are fighting a battle on all fronts and across a wide range of jurisdictions. What Circle is offering is a way to placate the regulators and remain compliant, with as much privacy as possible thrown in. And this will undoubtedly appeal to institutions and businesses, even if it won’t be the top choice for DeFi enthusiasts.

Disclaimer: The opinions in this article are the writer’s own and do not necessarily represent the views of Cryptonews.com. This article is meant to provide a broad perspective on its topic and should not be taken as professional advice.

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