Privacy coins Monero (XMR), ZCash (ZEC) and Dash (DASH) all experienced a price surge of over 20% in the 24 hours following a recent warning by the Australian Tax Office (ATO) that the agency has the ability to view transaction data from cryptocurrency exchanges and other businesses.

“While it appears that cryptocurrency operates in an anonymous digital world, we closely track where it interacts with the real world through data from banks, financial institutions, and cryptocurrency online exchanges to follow the money back to the taxpayer,” said ATO Assistant Commissioner Tim Lo in a statement.

Following the ATO’s statement on May 28 urging Australia’s 600,000 crypto traders to pay capital gains taxes on their holdings, the price of Monero — the most well-known and popular privacy coin — rallied from around US$220 to a high of US$293 the following morning. 

Monero’s sudden price surge was similar to its 30% gains seen on May 21, following the announcement by the U.S. Treasury that crypto transfers above US$10,000 must be reported to the Internal Revenue Service starting in 2023.

“Despite constituting a relatively small portion of business income today, cryptocurrency transactions are likely to rise in importance in the next decade, especially in the presence of a broad-based financial account reporting regime,” according to a May 2021 Treasury tax compliance plan for America.

Why privacy coins?

Privacy coins offer crypto traders the ability to hide the provenance of transactions as well as the identities of senders and receivers. For this reason, Monero and coins like Zcash and Dash are often used on dark web markets, where they are used widely in transactions involving illicit goods such as drugs and guns. 

In this case, some investors are now buying up these coins in huge quantities, likely to try to conceal their taxable cryptocurrency profits from regulators around the world, Justin d’Anethan, head of exchange sales at cryptocurrency exchange EQUOS told Forkast.News in an interview.

“Naturally, the idea behind privacy coins is to hide the sender of funds and/or recipient and take the cypher-punk ideals to its extreme, by enabling people to transact in a way that no governing entity can effectively track,” d’Anethan said.

While Monero, Zcash and Dash have all managed to rise in popularity in an otherwise plummeting cryptocurrency market, d’Anethan notes that “in the long run, they’re performing very close to the main market. XMR, DASH and ZEC are all down about 50% from their all-time highs… as are most coins across the crypto space.”

He also thinks it is unlikely these privacy coins will continue to outpace the broader market in the long-term, “simply because a large chunk of the capital is actually focused on operating in a credible/compliant way and so that allocations to non-compliant crypto projects will remain tame.”

A cypherpunk legacy

When Bitcoin was introduced as the first cryptocurrency, everyone initially thought its ownership and use were private and anonymous. But in reality, the users of Bitcoin as well as most of the major cryptocurrencies, including Ethereum and Ripple, are only pseudonymous. Bitcoin is supported by a blockchain that is essentially a distributed ledger, and each node that verifies the ledger has a full record of the entire history of all Bitcoin transactions that have occurred since inception. Therefore, these transactions can also be tracked, if the wallet can be linked or associated with an individual or entity.

“When you have blockchain analytics companies like Elliptic and Chainalysis, that are able to track addresses and transactions 20 layers deep, they’re able to link everything together,” said Trent Barnes, principal of ZeroCap, in an interview with Forkast.News. “The IRS and different government agencies are working with these type of companies — which make Bitcoin and Ethereum crap privacy coins, because essentially if you’ve interacted with a centralized exchange, chances are you can be identified.”

However, according to Joseph Liu, an associate professor of the Department of Software Systems & Cybersecurity at Monash University — whose research in linkable ring signature formed the theoretical basis of Monero — this problem also exists for those looking to cash out on their XMR.

“If you want to sell Monero into a fiat currency, just like the Australian dollar, of course, you need to go through the crypto exchanges and all Australian exchanges are registered with the government,” said Liu, in an interview with Forkast.News. “It is traceable because the money will be sent into your bank account once your Monero has been sold.”

Then why do privacy coins carry a reputation for tax evasion and money laundering risks? 

Role of unregulated markets and decentralized exchanges

“If people do not sell their Monero into the Australian cryptocurrency market, but instead choose to sell their XMR into markets without any regulation at all, then it’s quite hard for the Australian government to trace because they do not command any regulatory oversight,” Liu said.

Zerocap’s Barnes adds: “There are now decentralized exchanges (DEXs). In a DEX, no one knows who you are, you can be completely anonymous interacting with these unregulated exchanges on the internet.”

Barnes believes that the price surge of XMR, ZEC and DASH are “definitely heavily correlated” with the announcements from the U.S. Treasury and ATO of increased tax scrutiny on investors.

“Whenever you see privacy coins increase, it is usually due to the primary use cases of privacy concerns, such as governmental regulatory interference,” Barnes said. “The cypherpunks, they essentially wrote in their manifesto that someone has to write software to defend privacy. They took cryptography and privacy-enhancing technologies to create and enforce privacy, particularly within the digital world.”

In the U.S., the IRS has already spent millions of dollars trying to create ways to track tax fraud facilitated by privacy coins. In September 2020, the tax agency contracted two blockchain forensics firms — Chainalysis and Integra FEC —to develop ways to trace privacy coins. The IRS has also put a bounty of around US$625,000 for anyone who can crack Monero’s privacy technology.

As of yet, no one has managed to collect the reward.