What is Monero?
Monero is a private digital currency. Its only purpose is to be used as an exchange of money, similar to Bitcoin, Ripple, Litecoin, Dash, etc. It does not have characteristics of hosting other applications like Ethereum, EOS, Cardano, NEO, etc.
Many popular cryptocurrencies like Bitcoin are pseudonymous and trackable. Their public nature may lead to privacy leaks and diminished fungibility (interchangeable units).
Regarding privacy: some users may not want to expose how much of a cryptocurrency is in their wallet, and they may not want to expose their transaction history, but that information is accessible for certain cryptocurrencies like Bitcoin. If one were to spend $5 at a coffee shop, the coffee shop would not know how much money is in your wallet or what other stores he/she shopped at so why should it be different for digital currencies?
Regarding fungibility: fungibility is the property of a good or commodity whose individual units are interchangeable. For example, fungibility means that a 1-dollar bill is equal in value to another 1-dollar bill. It may be argued that Bitcoin is not a fungible form of money because trackable histories could taint certain Bitcoins. If a Bitcoin that had a history of drug trade use, would it be as valuable as a Bitcoin without that illicit history? In the status quo the answer to that question is probably yes, but what if there was a common way to red flag a bitcoin in the future for illicit activity? If that were the case, 1 Bitcoin would not always equal the value of a separate Bitcoin.
Monero features something called ring signatures, which hides the users and the amounts involved in a transaction. In conjunction with ring signatures, Monero uses something called key images, which enables privacy while preventing the possibility of a double spend issue and while also enabling somebody to prove that they sent a transaction if necessary. In summary, Monero is a private digital currency in which its history cannot be tracked while still enabling its users to prove that they made certain transactions.
Ring signatures explained
A ring signature adds decoy addresses (signatures) to the senders address so that they nobody can determine which of the group members’ address was the one that initiated the transaction. Because each address is equally likely to have initiated the transaction, there is no way for an outsider to trace the transaction. The sing signature function prevents any sort of potential fungibility issue possible with other digital currencies.
Ring Signature Example Diagram With Alice Sending Monero to Bob
Key images explained
If there is no way for an outsider to trace a transaction, how do we know that units are not being double spent? Also, how would somebody be able to prove that they sent a transaction if they needed to prove that they paid a bill for example? The answer is through a key image.
When a transaction is sent, a sender receives a generated key image, simi lar to a receipt. A key image is a cryptographic key derived from an output being spent and there is only one key image per transaction, yet it is impossible to tell which transaction created which key image. Miners can verify that the number of key images on the blockchain equals the number of transactions, so that there are no double spending issues.
To prove a transaction, somebody can share their key image. When they do so, they will only expose some information about their addresses, so that others can verify their transactions without compromising the identity of their private key. A public tool to prove transactions can be found here.
If Monero’s privacy features are still unclear, check out this explanatory video from Monero.
Methods that other privacy coins use
There are two other popular ways of ensuring privacy for digital currencies and there are several cryptocurrencies that use those methods. The two methods are CoinJoin and zk-SNARKS (zero-knowledge succinct non-interactive argument of knowledge) also known as Zero Knowledge Proofs. Dash is a popular cryptocurrency that uses CoinJoin and Zcash is a popular cryptocurrency that uses zk-SNARKS.
Briefly put, CoinJoin uses a centralized source to group transactions and their inputs (senders) and outputs (recipients), so that nobody can determine which inputs were responsible for which outputs. Although it is a quick process, the downside of CoinJoin is that it relies on a central source to group transactions.
zk-SNARKS is a method that proves that a transaction occurred without exposing the details of the transaction. zk-SNARKS is an effective way for preservice privacy but it requires greater computation and results in slower transaction times.
Other important features
Monero has some unique features in its forking policy, block size, and supply limit.
Monero forks frequently to upgrade features, which makes it more resistant to ASIC mining machines. ASIC machines would become obsolete after a short period of time if Monero changes its code, which will likely deter manufactures from creating ASIC machines.
-Dynamic block sizes
Monero’s block size limit dynamically changes to the median block size of the last 100 blocks. There is no hard limit, but if the soft limit is reached, there is a penalty to reduce block reward to prevent network spamming. Monero’s dynamic block sizes make Monero’s block size appropriately evolve over time. It removes a potential point of centrality (and failure) when deciding to change block size. This eliminates all block size arguments that have been known to segregate cryptocurrency communities (Bitcoin and Bitcoin Cash for example).
Once Monero’s supply reaches 18.3 million, it will increase at a constant rate of .3 Monero per block reward to ensure that miners have incentive to verify transactions, unlike Bitcoin, which will only reward miners with transition fees after its supply cap is reached.
The Monero team is led by a couple public leaders, Ricardo “fluffypony” Spagni and Francisco “ArcticMine” Cabañas but Monero has had over 200 contributors for their open sourced project.
Monero faces two major threats going forward: competitors and regulation.
There are several other privacy coins offering similar features that compete with Monero. Also, some coins such as Decred intend on adding privacy features, which could also tap into Monero’s market share. Additionally, potential second layer protocols like Enigma could add privacy to existing public and traceable blockchains.
Because of their anonymity and intractability, privacy coins are better suited for funding terrorism, drug trade, and money laundering than public cryptocurrencies. As a result, governments may attempt to ban private cryptocurrencies by making it illegal for businesses (and exchanges) to accept Monero. Although widely used decentralized exchanges may exist in the future that could be resistant to government regulation, potential government policy could weaken the demand for privacy coins.
By market cap, Monero is the most popular privacy coin at the time of writing this. It arguably offers cryptocurrency’s best privacy solution. It has an enthusiastic team that is dedicated to protecting privacy rights. There will always be a faction that values digital and monetary privacy, but potential government policy may interfere with demand. Monero should be one of the safer plays when investing in privacy coins, but BlockWolf’s research suggests that there are other privacy coins with more ambitious road maps that could lead to greater investment returns.