What you don’t see is what you get — Monero Fundamental Analysis
This fundamental analysis is one part of a paid newsletter from Crypto Consulting Institute that provides market insights, actionable trade signals, and fundamental analyses. For more information visit: https://www.cryptoconsultinginstitute.com/newsletter
It’s Friday night, and you’re sitting around the house with a handful of friends discussing plans for the weekend.
One of your friends floats the idea that ‘[we] should go camping for the weekend’.
During a brief pause in the conversation, you turn on your phone to check out your social media feed, only to find your feed is suddenly saturated with swags, tents, and sleeping bags.
You’ve never seen these advertisements, searched the items or typed in ‘camping’ as a search term. Yet, at that moment, your social media presents a curated array of items that you arguably would never have been exposed to before the discussion took place.
All those active on social media have experienced a similar phenomenon before. We can speculate on how a camping swag found its way onto your newsfeed from a verbal exchange. Still, the element of concern is that somehow your newsfeed was able to extract data to target you specifically.
The underlying ethical issue is the right to privacy. Social media accounts assure you that your data is anonymized, regardless your account is targeted based on inputs that determine your preferences. This exchange enables social media feeds to obtain advertising revenues, pay-per-click, and a cost covered by retailers marketing their products.
Seems benign, right?
Regardless, we know that nothing in this world comes for free, and if we don’t pay to open a social media account, we tend to pay in exchange for our data that gets curated in a way that targets our impulses, wants, and perceived needs.
Where it arguably is no longer harmless is if you decide that you want to purchase some cryptocurrency. Most of us, since 2017, have experienced banks actively blocking our deposits into a centralized exchange account to offramp into crypto. At this point, you have lost the supposed anonymity from your social media feed, as the bank effectively tells you what you can and cannot spend money on.
Many can argue that such controls should be in place, but this illustrates that money or the value of your energy (it takes time and effort to make money) can be interfered with by a third party.
There is a line where transactions that result from stealing your energy (scams and proceeds of crime) should be stomped out. But making the notion of privacy extinct in the name of safety does not address the root cause. Suppose you are law-abiding (99% of us are) and suddenly have frozen bank accounts or assets seized under the suspicion of anti-money laundering or anti-terrorism laws. In that case, we can begin to see how these processes to prevent crime adversely affect peoples’ lives.
A fair balance between a right to privacy and ‘the greater good’ must be struck, and neither should be deemed a mutually exclusive proposition.
Monero is the longest-standing privacy-enhancing cryptocurrency. While the value transfer proposition of Monero is straightforward, it utilizes some of the most advanced cryptography in the space. This FA will not touch on the complex mathematical equations that preserve your privacy. Instead, we will explore the mechanics at a high level and take a philosophical journey toward understanding the need for Monero in the current macro environment.
Controversial topics are unavoidable in this FA as we discuss privacy versus anonymity, why privacy is important, and what the other end of the privacy spectrum looks like in the form of CBDCs. The latter point contextualizes the seemingly brutal mission of regulators cracking down on privacy coins. We will also discuss emerging blockchain technology that seeks to make regulators’ efforts futile.
Privacy as a Rubik’s Cube
Monero is the largest privacy-enhancing cryptocurrency by market cap, founded in 2014 after it was forked from a 2012 project known as Bytecoin. The latter project was one of the first experiments with a decentralized and pseudonymous group of developers. However, the Bytecoin team were fractured by an absence of consensus and clear communication. Their conflicting work led to several forks, and Monero is one of them.
The Monero team have an interesting mix of doxed and pseudonymous contributors working together since 2014 to produce some of the most advanced cryptography in the space.
So, how does Monero ($XMR) work?
Somewhat inspired by Bitcoin’s Proof of Work design, Monero can be mined from a laptop or a smartphone. In a sense, Monero is arguably more inclusive and accessible than Bitcoin mining, as there are no ongoing changes to the mining difficulty.
A fundamental limitation of Bitcoin is that the network favours participants with the greatest computational capabilities, so it is no longer viable to mine $BTC from a laptop as you used to before the first halving. Monero’s difficulty remains constant and doesn’t impose the need for hardware updates through its reward-halving cycles. Since the RandomX hard fork in 2019, ASIC mining rig support was removed entirely to support existing CPUs. In other words, a standard computer or smartphone can validate the network, and there are no advantages to running higher-capacity GPU/CPU mining rigs.
$XMR transactions in practice involve miners offering not only their CPU power but their signatures to enable Ring Confidential Transactions (Ring CT). Ten other signatures are also required to push the transaction through each time a transaction broadcasts across the network. This achieves obfuscation of the origin address, making it impossible to discern which public address initiated the transaction. The upcoming hard fork in the middle of July will increase the number of Ring Signatures to 16 per transaction.
As an additional layer of privacy, each transaction generates a new public key (wallet address). While Monero holders have a root address, it always routes through a new public address, making it impossible to determine a wallet balance or actual recipient/sender. To achieve this, Monero employs a series of zero-knowledge proof processes sustained through some seriously complex Elliptic Curve mathematics. In the simplest of terms, zero-knowledge proofs involve proving that you know something without revealing what that thing is.
If that wasn’t enough, the on-chain trickery compounds further with decoy transactions known as mixins; Zero-value transactions are broadcast through the network to obfuscate the origin. Since transaction amounts are not recorded on-chain, there is no way of telling an actual transaction from a zero-value transaction.
A significant advancement that enhances the accessibility of Monero outside of centralized exchanges is through atomic swaps. This technology is remarkably complex in practice, but in simple terms, it involves a direct exchange between two parties to perform a trade within an agreed-upon time frame.
When both parties deposit the agreed-upon funds, they each generate a private key they exchange in secret. They are known as atomic swaps, as the outcomes are binary. Either each party deposits the agreed-upon sum of $BTC and $XMR into their contracts to complete the transaction, or the swap fails to take place within the specified time, and both parties are refunded. Neither party can take control of the generated private keys until the swap is complete. Given there are no third parties, such as a centralized exchange, atomic swaps are trustless, permissionless, and non-custodial.
Comparing $BTC to $XMR highlights a valid distinction, as the former is pseudonymous, and the latter is privacy-enhancing.
Why?
All transactions on the Bitcoin blockchain are published on an open ledger. Every single coin can be traced back to when it was first mined into existence.
While Bitcoin does not contain personal credentials, it does contain the public addresses of senders and receivers and the amounts sent. In practice, Bitcoin transactions can not only be traced back to being mined. Bitcoin transactions can be traced to a centralized exchange that requires, when requested by law or tax enforcement agencies, to disclose a customer’s identity, including wallet addresses to which a customer withdraws. Most CEXs have KYC requirements before you are permitted to take control of your Bitcoin. In this sense, you are anonymous when transacting on the Bitcoin blockchain until an audit path is followed back to sources that require KYC; thus, pseudonymous.
$XMR, on the other hand, cannot be used in an audit trail that reveals your identity. The Monero ledger does not record the amount spent while the receiver and sender addresses are obfuscated through ring signatures, decoy transactions, and mixins.
Your Privacy or Your Security — You Can’t Have Both.
Going into the future, we need to become ever mindful of the role of regulators in imposing an agenda on the cryptocurrency space. Two multinational institutions are worth touching on as they appear to reflect the will of regulators toward cryptocurrencies: the Bank for International Settlements (BIS) and Financial Action Task Force (FATF).
BIS is the bank for central banks — owned by the 63 central banks that make up its membership. In recently revised working papers, it is clear their stance toward cryptocurrencies is ultra-aggressive — especially toward privacy coins.
Their purpose is to facilitate the research and support the development of central bank digital currencies (CBDCs), and as quoted by the head of the BIS, their goal is to ensure that:
“Central Banks will have absolute control over how money is spent” — Agustin Carsens
In other words, not only are they seeking to maintain hegemony over money, but they are also seeking to alter blockchain technology to enhance their control over financial systems further.
Our recent FA on Ripple touched on CBDCs, but briefly recalling the differences between cryptocurrencies and CBDCs is important. The former is premised upon trustless exchange, permissionless environments, decentralization, tamper-proof, and censorship resistance. CBDCs are the complete opposite, and the only thing they have in common is using a digital ledger to record transactions.
The May revision of the BIS’s regulation wishlist stated the aims of the paper are the research and development of governance (control) of money practices and ‘embedded supervision’ of smaller fintech companies (DeFi projects) to ensure a “level-playing field” with traditional financial institutions.
Agustin rationalizes in the paper that “supervision should evolve in parallel with technology” and that embedded supervision requires modifying the consensus mechanism of blockchains to ensure a distributed ledger is permissioned. In other words, central banks and financial regulators control who maintains the network and determine what financial information is available to the public. Entirely at odds with what blockchain technology was initially designed to do.
FATF’s original purpose was to combat global money laundering, but its scope has expanded to “protecting the integrity of the financial system”. By their origins, Cryptocurrencies were purposed to replace the existing financial system and are clearly at odds with the FATF’s mission statement.
Why is all this relevant to Monero and other privacy-enhancing cryptocurrencies?
In the FATF’s recent 111-page report, containing over 357 recommendations, virtual asset service providers (VASPs) are required to comply with tracking the use of privacy coins, transactions occurring from FATF non-compliant jurisdictions, any large transactions deemed suspicious that can not be explained, and the origin of a users’ money.
In plain terms, privacy coins are entirely at odds with the goals of multinational financial institutions like the IMF and World Bank, central banks, the US treasury department, and financial regulators. Transactions with privacy coins cannot be traced through an audit trail in the same way that the likes of Bitcoin can. Despite numerous claims that blockchain analytics firms have assisted law enforcement by providing them with “useful leads, “ nothing about the user’s identity can be ascertained from peer-to-peer transactions on the Monero blockchain.
Despite having some of the most advanced cryptography in the space, there are clear efforts by blockchain analytics companies, and perhaps other unknown actors, toward decrypting private transactional information. Indeed, a bug in Monero was identified that could reveal the original ring signature that initiated a transaction. The bug occurred when multiple transactions were conducted in quick succession. The fix to this was to wait for an hour between transactions, which is no doubt inconvenient but certainly not a deal-breaker to preserve privacy. Further, the bug did not reveal other aspects of the transaction, such as the receiver address or amount transacted.
A noteworthy mention was the arrest of a founder, Richard Spagni, charged with fraud of up to $100,000 from false invoicing. One can speculate whether the arrest was politically motivated or legitimate. Still, the outcome of those proceedings is yet to be seen, and there is no evidence of $XMR being utilized in any founder’s illicit activities.
Monero Tokenomics (As of 28/06/22)
Price: $117.57
Market cap: $2.13B
All-time high: $517.77
Circulating Supply: 18,140,426
No Max Supply, $XMR to be mined through PoW indefinitely.
The Old ‘If you’ve got nothing to hide…” Trope — Discussion
Sacrifices have been required throughout history so that the world can move toward a future grounded in peace, freedom, stability, and post-scarcity. Although at what point do we decide that one bad apple should not spoil the bunch.
Government overreach is nothing new. Since anti-terrorism legislation arose two decades back, we have encountered documented instances of surveillance institutions like the NSA wiretapping their citizens and war crimes committed in foreign jurisdictions, as exposed by Wikileaks.
When it comes to “If you’ve got nothing to hide, you’ve got nothing to worry about”, we need to accept there are limits of truth to this trope, but it is important to reflect on the distinction between privacy and anonymity.
If you are conversing with friends about camping, exposure to content specific to those conversations doesn’t bode well if you care about privacy. It becomes insidious to consider how data is extracted and finds its way onto your social media feed. Should an intimate conversation be documented by an unknown third party, what are the implications to your sense of privacy from that? How could that information be used against you in the future?
Further, why is this relevant to Monero and privacy coins in a broader context?
If you purchase three coffees a day or are someone that chooses to smoke and spend their money out at a pub occasionally, whose business is it that you enjoy the odd beer, wine, or cigarette other than your own?
There are systems in this world that monitor your spending habits and your general behaviours. If your behaviours or history puts you in a bracket that deems you a “good” citizen, then you can travel on public transport at a discount. If the state considers your behaviour deviant, you pay full price.
While this sounds like a dystopian or tinfoil hat scenario pulled straight out of George Orwell’s 1984, financial censorship does occur under the Chinese Social Credit system, and it is real. The Chinese Digital Yuan, one of the first major CBDC experiments, has been used to suppress those that would speak out against the regime.
Not just in China, we have also seen a lite version of this play out in Canada with GoFundMe contributors having their bank accounts temporarily frozen. Regardless of the motive (economic or political), it is impossible to turn off a decentralized privacy coin network, making them enemy #1 to regulators.
The primary justification for openly seeking to bury privacy coins is often under the guise of anti-money laundering and anti-terrorism laws. First and foremost, these are measures applied to everyone that are enforced to present a disincentive to an ultra-minority.
It is not to say that cryptocurrencies are not used as an instrument for dishonest folks to break the law. They most certainly are, and there is nothing new about criminals using nascent technologies to outpace authorities. But as many crypto investors have experienced, inferences are drawn from your purchase of cryptocurrencies by banks that then have the power to freeze your accounts indefinitely. Inconvenient at the least and harmful at the most to those innocent and literally “have nothing to hide”.
Further, it has never been more critical to control your money in a global macro environment of ongoing inflationary pressure that pushes nations closer toward ideas such as bank bail-ins and CBDCs.
As indicated above, measures taken to punish criminals are often circumvented through technological loopholes or avoided entirely by withholding stolen assets. Leaving only the majority who have done nothing wrong to curb their behaviours to be compliant with these measures.
The underlying issue is the root cause of financial theft, or spending money toward illicit ends is not resolved by punitive regulatory measures. Taking a one-size-fits-all approach does not prevent criminality and ultimately causes more harm than good, not just ethically but also through a cost/benefit lens. We see this to some extent playing out in geopolitics. US Dollar Sanctions targeting Russia have prompted their commodities to be exchanged for Russian Ruble, putting tremendous pressure on US dollar hegemony. An unintended consequence of excessive intervention in financial markets.
However, regulations and oversight are not all doom and gloom. The sector needs greater clarity and protections to give investors and future users confidence.
Cryptocurrencies, particularly Bitcoin advocates, are highly active in lobbying politicians. Note that Sam Bankman-Fried donated $5.2M to the Biden 2021 campaign and remarked that he may be inclined to donate between $100M — $1B to Biden’s 2024 campaign.
Regardless of political motives, the donations may have bought some goodwill in Washington that as seen in recent bills put to the house. It is worth noting that CBDCs are incredibly unpopular among those that understand and advocate blockchain technology.
US Senator Cynthia Lummins, considered one of the strongest crypto advocates in Washington, presented a final draft bill seeking regulatory clarity for cryptocurrencies. In short, some key takeaways from the draft bill were from the definitions used:
Commodities: any asset with price changes being a sole supply and demand factor.
Security: any asset where the price is influenced by the activities of a centralized entity or company.
Digital asset: “A natively electronic asset that confers economic, proprietary, or access rights or powers to its holder, and is recorded on a cryptographically secure distributed ledger technology or a similar analogue.”
Bringing it back to Monero, it falls under the definition of a ‘commodity’ and ‘digital asset’.
Without a doubt, the biggest threat to Monero is regulation and the measures enforced to limit access. At this point, it is incumbent on centralized exchanges to delist Monero and other privacy coins like ZCash.
Fortunately, regulatory bodies are aligned that fully decentralized digital assets and networks cannot be stopped. Monero is no different. While one may not be able to access it from a centralized exchange readily, anyone with a computer or smartphone can install permissionless software to mine $XMR.
Also, the continued development of Atomic Swap technology that enables trustless and permissionless peer-to-peer exchange cannot be shut down. Nothing prevents anyone from purchasing $BTC and withdrawing it into their wallets to initiate an Atomic Swap for $XMR. As more currencies such as $ETH become available to atomic swap for $XMR, there will only be more ways to circumvent CEX delistings in the future.
Furthermore, we must consider the level of fungibility that comes with holding $XMR. If you purchased $WBTC from a Decentralized Exchange on Ethereum, you might be inclined to bridge back onto the Bitcoin blockchain. The $BTC unlocked from the bridge has a history tied to a suspected crime. From a fungibility perspective, this $BTC may be arguably less valuable than another $BTC because there is more risk of gaining undue attention from law enforcement agencies.
From an investment perspective, we can expect significant long-term volatility on $XMR to reflect the movements of regulators. However, these regulations have shown that criminals may use $XMR to obscure their illicit activities and go ‘underground’.
In this sense, there is a likelihood that the price of $XMR can hold up from illicit funds being backed into a corner. While that is far from ideal and perhaps unethical to bank on this notion, there are legitimate reasons for investors to obtain $XMR to avoid being reduced to a behavioural statistic or being subject to unfair scrutiny.
Unless regulators find a way to alter existing blockchains’ consensus to be permissioned (an explicitly stated goal of the BIS), a truly decentralized protocol such as Monero cannot be shut down. Instead, if the BIS gets its way, it will become one of many chains that will be blacklisted from the mainstream and be treated with the same stigma that the dark web receives today.
As far as price goes, $XMR is currently 78% away from its all-time high, which is comparatively better than other altcoins in this bear market. Further, it has maintained a consistent presence within the top 100 cryptocurrencies since its inception.
As we can see, no other privacy coin holds a candle to the number of transactions performed on Monero. By this comparison, we can confidently assert that there are no concerns about competitors taking market share.
While Monero has exit liquidity risks in response to regulations, it does play favourably into the narrative of those seeking to avoid economic sanctions (whether legitimate or not).
The purpose of this piece was not to wax on about privacy and political ethics but to provide food for thought as purchasing $XMR as a longer-term investment would be suitable if it aligns with your privacy values. One can capitalize on $XMR in response to macro events and ongoing development milestones, but in the near term, it is safe to say that $XMR will have a target on its back for regulators to throw FUD darts at for some time to come.
References
Bitcoin-Monero Cross-Chain Atomic Swap, https://www.getmonero.org/2021/08/20/atomic-swaps.html
BIS, ‘Embedded supervision: how to build regulation into decentralized finance’, Revised May 2022, https://www.bis.org/publ/work811.pdf
CBDC Insider, ‘CBDC is a Tool to Combat Bitcoin, Says Bank of Indonesia Exec’, 2nd December 2021, https://cbdcinsider.com/2021/12/02/cbdc-is-a-tool-to-combat-bitcoin-says-bank-of-indonesia-exec/
Cryptobriefing, ‘Monero’s Riccardo Spagni Arrested on Fraud Charges’, 2nd August 2021, https://cryptobriefing.com/moneros-riccardo-spagni-arrested-on-fraud-charges/
Coindesk, ‘Bug Found in Decoy Algorithm for Privacy Coin Monero’, 27th July 2021, https://www.coindesk.com/markets/2021/07/27/bug-found-in-decoy-algorithm-for-privacy-coin-monero/
Coinloan, ‘The Complete History of Monero (XMR)’, https://coinloan.io/article/the-complete-history-of-monero-xmr/
Cointelegraph, ‘Regulations and exchange delistings put future of private cryptocurrencies in doubt’, 16th June 2022, https://cointelegraph.com/news/regulations-and-exchange-delistings-put-future-of-private-cryptocurrencies-in-doubt
FATF, ‘UPDATED GUIDANCE FOR A RISK-BASED APPROACH — VIRTUAL ASSETS AND VIRTUAL ASSET SERVICE PROVIDERS’, October 2021, https://www.fatf-gafi.org/media/fatf/documents/recommendations/Updated-Guidance-VA-VASP.pdf
Ledger Insights, ‘Anti-money laundering has less than 1% impact on crime. At what cost?’, 25th September 2020, https://www.ledgerinsights.com/anti-money-laundering-has-less-than-1-impact-on-crime-at-what-cost/
Medium, ‘Zero-Knowledge Proofs: Example with Pedersen Commitments in Monero’, 6th April 2021, https://medium.com/coinmonks/zero-knowledge-proofs-um-what-a092f0ee9f28
Monero Whitepaper, Nicolas van Saberhagen, 17th October 2013, https://www.allcryptowhitepapers.com/Monero-Whitepaper/
Mycryptopedia, ‘Monero Atomic Swaps Explained’, 12th July 2021, https://www.mycryptopedia.com/monero-atomic-swaps-explained/
Openhub, ‘Monero [Developer Activity]’, https://www.openhub.net/p/monero
Youtube, 99Bitcoins, ‘What is Monero? A Beginner’s Guide’, 23rd April 2019, https://www.youtube.com/watch?v=qrUq0v5VgdU
Youtube, Coinbureau, ‘Monero: XMR Potential in 2022?! This You NEED To Know!!’, 4th May 2022, https://www.youtube.com/watch?v=7-aTYyEVlNk&t
Youtube, Coinbureau, ‘Have You READ THIS?! FATF’s CRAZY Crypto Plans!!’, 7th November 2021, https://www.youtube.com/watch?v=nFSOfkalDK4
Youtube, Coinbureau, ‘HAVE YOU READ THIS Crypto Bill!? Regulations Incoming!?’, 26th June 2022, https://www.youtube.com/watch?v=2AdlIjaZ40
Youtube, Coinbureau, ‘Have You READ THIS!? The DeFi Crypto Regulation THEY Want!!’, 16th June 2022, https://www.youtube.com/watch?v=CIRsEOBYxbA
Youtube, Whiteboard Crypto, ‘What is Monero? XMR Explained with Animations’, 31st August 2021, https://www.youtube.com/watch?v=B7sLnmlZ-kU
