Bitcoin Privacy Extension to Have Backdoor for Government Snooping?

Bitcoin banknote concept – Wikimedia Commons

Bankers seem desperate to get governments to regulate decentralized virtual currencies like Bitcoin. With good reason.

As currency wars rage with a rush to devaluation while banker bureaucrats openly rob depositors in Cyprus and as financial privacy disappears, Bitcoin has become a safe haven currency to a growing number of people. Bankers and governments can’t control it or tax it, but now they’re attempting to fix that.

Andrew Leonard of Salon writes:

The more popular Bitcoin gets, whether as a symbol of resistance or a perceived safe haven in financially troubled times, the more government attention it will inevitably draw, and the more inexorably it will be sucked into existing regulatory structures. Incomes denominated in Bitcoins will be taxed. Efforts at money laundering will be cracked down upon. It’s the price of success. Resistance is futile.

Last week, the Financial Crimes Enforcement Network (FinCEN) revealed their initial guidelines to regulate virtual currencies. Although it said that users of virtual currencies are not subject to FinCEN regulations, exchanges for that currency are:

A user of virtual currency is not an MSB under FinCEN’s regulations and therefore is not subject to MSB registration, reporting, and recordkeeping regulations. However, an administrator or exchanger is an MSB under FinCEN’s regulations, specifically, a money transmitter, unless a limitation to or exemption from the definition applies to the person. An administrator or exchanger is not a provider or seller of prepaid access, or a dealer in foreign exchange, under FinCEN’s regulations.

Additionally, the CIA’s venture capital firm In-Q-Tel has taken a great interest in Bitcoin and has called some of its developers to give a presentation about Bitcoin this June, which is troublesome for the prospect of freedom and privacy.

But resistance is not futile as Andrew Leonard would like his readers to believe. Other developers are working on Bitcoin extensions to add further privacy for users. Bitcoin transactions are already fairly anonymous even though they can be viewed on a public open-source record.

Privacy lacks for Bitcoin users, not in the transaction, but in where the coins are stored. Specific encrypted coins can be traced through a transaction to a certain wallet whose owner is may or may not be anonymous. Even if the wallet is anonymous, everyone knows where their specific coins have been which could potentially expose the wallet owner’s activity and identity.

A new Bitcoin privacy extension, Zerocoin, is seeking to solve this privacy concern. Zerocoin, being developed by Johns Hopkins University, will basically pool Bitcoins in escrow and scramble them between buyers and sellers to hide the origin and destination of specific coins.

New Scientist reports:

Called Zerocoin, it’s a cryptographic add-on to Bitcoin that allows for transactions which cannot be linked together. The key is that it does this without introducing any new centralised elements into the network or using laundering, whereby coins are spent through intermediaries to hide the root purchaser’s wallet address.

Zerocoin works by allowing Bitcoin users to leave their coins floating on the network for someone else to redeem, on the condition that they can redeem the same amount of Bitcoin, similarly left floating on the network, at an arbitrary time in the future.

Jon Matonis of the American Banker interviewed Johns Hopkins research professor Matthew Green, who said:

“Zerocoin creates an ‘escrow pool’ of bitcoins, which users can contribute to and then later redeem from,” Green explained. Users receive different coins than they put in (though the same amount) and there is no entity that can trace your transactions or steal your money. “Unlike previous e-cash schemes, this whole process requires no trusted party. As long as all the nodes in the network support the Zerocoin protocol, the system works in a fully distributed fashion,” added Green.

Green is due to present his paper Zerocoin: Anonymous Distributed E-Cash from Bitcoin at the IEEE Symposium on Security & Privacy this May.

It sounds like an amazing innovation for a currency that is already far superior in many ways to establishment currencies and banking. However, Green adds one disturbing statement with huge implications for the legitimacy of Zerocoin.

Green told the New Scientist, “Zerocoin would give you this incredible privacy guarantee, then we could add on some features which let the police, for instance, to be able to track money laundering. A back door.”

Apparently Green has received a lot of grief for attempting to provide an anonymous privacy protocol that would allow back-door snooping, and he has since backed off his previous statement even if it still appears in his paper.

“The back door isn’t part of Zerocoin. There’s absolutely no need for it, and building one in would take significant additional effort. In fact, we only mentioned it as a brief note in the conclusion of our paper, mostly to motivate future research work,” Green told the American Banker.

So Green included the idea of a backdoor to “motivate future research work”? In other words, he seems to be seeking public funding to continue creating this backdoor. Obviously, the “authorities” would be the only ones interested in this pursuit which answers the question about who he is trying to motivate. The bigger question is who funded this work?

In an attempt to put the issue to rest, Green claimed that a backdoor was impossible, anyway; “If someone did try to build a back door for any reason, the open source Zerocoin would quickly become Zero-adoption.”

In any respect, creating a random escrow pool for Bitcoin transactions is a brilliant concept and an innovation that can be used alongside other open-source programs like Coin Control which allows users to choose what wallet they want individual transactions to go to.

Yet as Bitcoin developers are hard at work finding ways to make it even more anonymous, will they be successful in preventing backdoors for government access, thwarting FinCEN regulations, and involvement by the CIA?

Read other articles by Eric Blair Here