Shielded Transactions

Source: Publish0x

Breaking the Ice

In contrast to what you think, blockchain is pseudonymous, not anonymous. Anonymity is being unidentifiable while pseudonymity is having a public, yet unknown identity (think of it as hiding in plain sight). Blockchain is a public ledger meaning transactions are public records; which means wallet addresses (users’ account info) are also public records although they can’t be easily traced back to the real users.

The bedrock of blockchain transactions is pseudonymity which drives transparency. Every blockchain user can see transactions on the network which is not the case in traditional financial institutions. This transparency has proven effective in creating a trustless and accountable system, fishing out individuals and institutions that scam people because transactions can be traced. However, this has raised privacy concerns.

Introducing shielded transactions — a solution to making transactions untraceable, thus addressing these privacy concerns. Let’s dig in.

What are Shielded Addresses?

Mempools (memory pools) are “waiting rooms” for pending transactions before entering the blockchain. These mem pools are public, so anyone who has access to the internet can see what’s going on on-chain, who’s sending what token to whom, and stuff like that (no technical knowledge required). These transactions wait in a queue where they are selected to be verified by validators before they are sent to the blockchain. Public mempools provide the perfect opportunities for MEV exploitations.

Top image: A Bitcoin mempool; Bottom image: Etherscan, a blockchain explorer to see pending Ethereum transactions that are in the mempool

Note that there are blockchains like Solana that don’t use mempools. However, they are still subject to MEV attacks.

Typical wallet addresses and transactions are transparent. Shielded addresses, however, are encrypted addresses designed to make transactions private. They require the creation of zero-knowledge proofs (zkSNARKs) to validate the transactions. Zero-knowledge protocols are used to encrypt the senders’ and receivers’ addresses. Transactions that occur between two shielded addresses are called shielded transactions.

What are Shielded Transactions?

Shielded transactions are transactions that occur between two shielded addresses. A shielded address sending tokens to a shielded address will result in a shielded transaction, just as how a transparent address sending tokens to another transparent address will result in a transparent transaction (like we’re familiar with). A transparent address sending funds to a shielded address will still result in a shielded transaction. A shielded address sending tokens to a transparent address would result in an unshielded transaction,

Zcash, a privacy-focused cryptocurrency is known to have pioneered the use of zero-knowledge tech (particularly zk-SNARKs) in the cryptocurrency system. Zcash provides users with the option to send either transparent or shielded transactions. Shielded transactions are encrypted such that information like wallet addresses, amounts, and even transaction history is untraceable. Zcash users can send shielded transactions when they have shielded Zcash addresses. This tends to improve privacy and secrecy. One limiting factor with the Zcash approach is that it supports a single asset only — its native token, ZEC. Zcash introduced Sapling to generate shielded addresses.

What is Sapling?

Sapling was introduced by the Zcash team in 2018. It is an upgrade that improves privacy in transactions. Sapling requires two keys to enable shielded addresses & transactions and they are viewing keys and spending keys.

Viewing Key: This key allows users to decrypt and see transactions coming into shielded addresses or being sent from shielded addresses. They can be used to see transaction value, memo field, and the addresses sending or receiving.

Spending Key: This key is used to send tokens into or out of a wallet privately. These are what we refer to as private keys in transparent transactions because they are used to create and authorize payments.

The viewing key is used to generate sapling addresses where users can send tokens to and from. Then the spending key is used to access the tokens & authorize spending from shielded addresses.

What are Shielded Pools?

Just like regular pools, shielded pools are pools comprising cryptocurrencies. However, unlike regular pools, the wallet addresses of users who pool their tokens in shielded pools are well hidden from outside observers until they remove them from the pools. Only the sender and receiver can view the transactions once they’re in the pool, not an external eye. Shielded pools are protocols for depositing tokens to protect various assets, including fungible and non-fungible tokens. Additionally, some shielded pools are designed with algorithms that synchronize user incentives, rewarding users who add tokens to the pool to contribute to shielding. When tokens are deposited to shielded pools, that is when they’re referred to as shielded tokens.

Types of Shielded Pools

Single-asset shielded pools: These are pools that allow the sending and receiving of a single token like Zcash does.

Multiple-asset shielded pools (MASPs): These are pools that allow multiple tokens to exist in a single shielded pool. Various tokens (ERC-20) and token standards (ERC-721) cohabiting in a pool create a diversified pool that is large enough to conceal transactions and make them impossible to track. Panther Protocol is an example of a project that offers multi-asset shielded pools for users.

How it Works

Shielded pools make use of zero-knowledge proofs and encrypted notes.

The more tokens deposited in a shielded pool, the more hidden the transactions are. Let’s examine how shielded transactions, addresses and pools work using our famous on-chain couple, Bob and Alice.

For instance:

Bob wants to send Alice 350 XYZ tokens from his regular transparent address and he doesn’t want anyone to know anything about the transaction not even the transaction value. Assuming Bob wants to perform this transaction with an entirely new wallet and address, he first creates the new wallet, using the Sapling protocol which generates a shielding address for him. He then converts his 350 XYZ to shielded tokens (let’s call it 350 sXYZ) using a shielding protocol.

So, Bob’s newly created wallet is credited with the 350 sXYZ (the shielded version of his 350 XYZ) and his transparent wallet is debited 350 XYZ. He deposits the shielded tokens to the protocol’s shielded pool (where multiple tokens deposited by others also reside). The shielded pool “mixes” the tokens in it so it would be difficult for an external observer to know the token’s destination (Alice’s address).

The 350 XYZ token is then sent to Alice’s address from the pool and she won’t have much access to other information about the sender except the value of the token she just received (if she receives it via a transparent address). However, if she receives it with a shielded address, she can see any other encrypted info sent by Bob.

No outsider will be able to trace the transaction in the pool. All they know is that some transactions went in and came out but they can’t tell which address sent what token to another address. Meaning, that inputs are not easily linked to outputs in shielded pools.

Shielded pools are more efficient in providing privacy when the tokens are deposited in the pools for a long (or average) period because it will be much more difficult to link a deposit to a withdrawal that takes place days after.

How Shielded Pools Can Be Useful

• Privacy in asset transfers: Shielded pools help keep transactions private and confidential, thereby securing the financial information of users.
• Voting: Zero-knowledge proofs in shielded pools ensure vote integrity and voters’ anonymity across various blockchains.
• Mitigate MEV in trading: This can prevent searchers from looking for MEV opportunities because transactions are kept private in pools.

Closing Thoughts

While shielded transactions, addresses, and pools drive the mission of true privacy in blockchain technology, it has its downsides. It can be used by bad actors to perform illegal transactions that remain untraceable. Some blockchains can mandate protocols with shielded pools to perform KYC for users (when they register for the platforms) to prevent illegal actors from using the pool.