Monday, April 18, 2022

A Downside Of Privacy

Monero claims that:
Observers cannot decipher addresses trading monero, transaction amounts, address balances, or transaction histories.
This is all very well for individuals transacting with each other in the Monero ecosystem, but unless they are cryptojacking (mining using malware), miners need to pay bills for power and hardware in fiat currency. And miscreants using Monero to launder the loot need to convert Monero to fiat in order to buy the Lamborghini. So the Monero ecosystem needs exchanges, and thereby hangs a tale I pursue below the fold.

Exchanges in the Monero ecosystem support four kinds of transactions:
  1. An account holder transfers some Monero to the exchange. The exchange adds the Monero to its reserves and increments the account with the amount of Monero.
  2. An account holder transfers some non-Monero currency, fiat or cryptocurrency, to the exchange. The exchange increments its holdings of the input currency, and increments the account with the corresponding amount of Monero.
  3. The acccount holder withdraws some Monero. The exchange transfers the amount of Monero from its reserves to the account holder, decrementing both its reserves and the account.
  4. The account holder withdraws some non-Monero currency. The exchange decrements the account by the corresponding amount of Monero, and transfers the output currency from its holdings to the holder.
The interesting point is that, because this is Monero and "Observers cannot decipher ... address balances", there is no way for outsiders to know how much Monero the exchange has in its reserve. An untrustworthy exchange could be running fractional-reserve banking, owing its account holders more Monero than was in its reserves and "banking" on the idea that the holders won't cause a "bank run" by all asking for their Monero at the same time.

In Monero holders plan a bank run, Molly White reports that this idea might be wrong:
Monero is a privacycoin that attempts to address some of the privacy issues with more popular currencies (like Bitcoin or Ethereum) — namely, that anyone can see that wallet A sent a transaction of X amount to wallet B. However, privacy cuts both ways, and this feature also means that, without cooperation from the exchanges, the Monero community can't verify that exchanges actually hold the amounts of Monero they're allowing their users to buy. Some in the community have become increasingly suspicious that exchanges are selling "paper Monero": fake Monero that's not actually backed by reserves.

To try to test this theory, Monero users have scheduled what is basically a bank run: they are encouraging all users to try to move their Monero out of exchanges on April 18. Some have claimed that exchanges including Binance and Huobi have frozen withdrawals of Monero in anticipation of the mass-withdrawal, in an effort to prevent their lack of reserves from being discovered. Indeed, Huobi suspended XMR deposits and withdrawals 10 days ago and has yet to restore the functionality, which they say is due to a wallet upgrade. Binance also shows "withdrawal suspended" on its status page as of April 14.
There is a way for an exchange to expose the amount of Monero in its reserves, by sharing a "view key" but, as 'The Monerun' scheduled for April 18th, Monero's 8th birthday points out, few if any do:
This a reaction against on-going CEX shady practices involving paper Monero. Instead of providing transparency reports (share view keys), exchanges are known to suspend XMR withdrawals and misrepresent their reserves.
Suspending withdrawals is the normal reaction to a run on a fractional-reserve bank. After all, they do not have the reserves to satisfy the demand for withdrawals. In this case it is a signal that Binance, Huobi, Poloniex and possibly others are worried that they might be found to have succumbed to the temptation to make vast profits by running fractional reserve banking.


  1. The Chainalysis team reports that Mixer Usage Reaches All-time Highs in 2022 With Nation State Actors and Cybercriminals Contributing Significant Volume:

    "As we can see, the increases come primarily from increased volumes sent from centralized exchanges, DeFi protocols, and most notably, addresses connected to illicit activity. DeFi protocols in particular have risen not just in terms of value sent to mixers, but also in terms of the share of all volume sent to mixers, which makes sense given that the timing coincides with DeFi’s increasing prominence within the overall cryptocurrency ecosystem.

    The increase in illicit cryptocurrency moving to mixers is more interesting though. Illicit addresses account for 23% of funds sent to mixers so far in 2022, up from 12% in 2021."

  2. Zooko Wilcox has a two-part post entitled Someone associated with Monero organizing and funding false-flag attacks on Zcash discussing some of the shenanigans going on in the anonymous cryptocurrency world.