H1 2023: The State Of Privacy Coins

Summary It's been a rough 2023 for the privacy coin market. Major headwinds include regulatory actions, exchange delisting, and consumer apathy. The Horizen blockchain developers recently announced the deprecation of the network's shielded coin pool; rendering ZEN no longer a "privacy coin." Zcash developer Electric Coin Company is reducing headcount, the SEC has labeled Dash an unregistered security, and NFTs on Monero risk degrading the network's privacy. It's been a rough 2023 for many altcoins in the cryptocurrency market. With US regulators ramping up enforcement actions against exchanges and designating certain coins to be unregistered securities in the process, many coins are at or near cycle lows at the midway point of the year. We've seen some of the recent securities designations of coins like Polygon ( MATIC-USD ), Cardano ( ADA-USD ), and Solana ( SOL-USD ) lead to their delisting by several US-based crypto exchanges. Being delisted led to sharp drops in coin prices. As a more niche segment of the altcoin market, "Privacy coins" have not done particularly well in 2023 either. The top 2 privacy coins by market capitalization are Monero ( XMR-USD ) and Zcash ( ZEC-USD ). Data by YCharts Each of those coins have dramatically lagged the year-to-date performance of Bitcoin ( BTC-USD ) and for Zcash specifically, that YTD performance has actually seen the coin down by as much as 40% just a few weeks ago. Though ZEC and XMR are the biggest coins in the privacy segment, there are a couple of others worth mentioning as there have been some important developments. Exchange Delisting While general apathy toward the segment from the broader crypto community has always been a problem, in my view the biggest battle privacy coins face at this point is simple availability. Last September , crypto exchange Huobi announced it would stop offering privacy coins like XMR, ZEC, Dash ( DASH-USD ) and Horizen, among other coins. The main driver cited by the exchange was regulatory pressure and compliance concerns with AML/KYC policies. While Houbi is a formidable exchange for trading volume and pairings, the big hammer on privacy coins arguably came in late-May when top crypto exchange Binance ( BNB-USD ) said it would be delisting 12 privacy-centric coins. Among them, the four coins mentioned in the previous paragraph and many lesser-known coins like Decred ( DCR-USD ), Verge ( XVG-USD ), and Secret ( SCRT-USD ) in certain European countries including France, Italy, Poland, and Spain. Interestingly, just a few weeks later Binance partially reversed that late-May decision and announced that it would continue to allow trading of Decred, Dash, Zcash, Secret and Verge in the aforementioned EU countries. Notably missing from the exchange's privacy-coin walk-back were Monero and Horizen. One of the clear differences between coins like Monero and others like Zcash is the fact that Monero is private by default and lacks a transparent option. Zcash and Dash each have private or transparent optionality. Horizen Dropping Shielded Pools The regulatory environment for privacy coins has led to somewhat extraordinary measures being taken by the developers of the Horizen blockchain. Horizen's core developer is Horizen Labs. Horizen Labs was co-founded by Rob Viglione. In a medium post from January, Viglione detailed the decision to move Horizen away from a privacy-focused blockchain and instead position the network as more of a network of blockchains: ZenIP 42204 was put together in response to community concerns about privacy projects getting slammed by regulators. As Horizen has matured into a network of blockchains, is launching a smart contracting platform, and is aggressively pursuing enterprise, government, and academic use cases, there's a growing sense that all of this could be smashed by regulators for a feature that almost no one uses. It turns out that less than 0.4% of ZEN is parked in the shielded pool. 99.6% of ZEN is not. The shielded pool usage is an important metric to consider because the Sprout technology that Horizen has been using is similar to what Zcash has through its ZEC shielded pool. However, on Zcash, the shielded supply of the coins outstanding is closer to 10%. It could be argued Horizen is taking a somewhat pragmatic approach to navigating the regulatory climate since the chain isn't really being used for shielded transactions. What's important to note regarding Horizen's shielded ZEN pool is that in deprecating the pool, ZEN can't go into the shielded pool, but it can come out of the pool. This means the holders of the 0.4% of the ZEN that is shielded won't lose their coins. According to Horizen, this pool will be deprecated on testnet in August and on mainnet in September through a mandatory software upgrade. Horizen Development & Grayscale Ownership The decision to eliminate shielded pooling of ZEN on mainnet may speak to a larger issue with Horizen; there doesn't appear to be any meaningful application built on the network and the push for the EVM-compatible EON sidechain might be too little too late for Horizen. Horizen Development (Santiment) Still, though there isn't much to speak of from an application standpoint, there has been a noticeably positive trend in the Horizen network pertaining to development contributors. During the depths of the last crypto bear market, the active contributor count on Horizen was generally in the 3 to 5 contributor range on a 7-day timeframe. However, that figure is now generally closer to 25 on a regular basis. Data by YCharts Despite being a relatively small network, ZEN exposure has been available on the public equity market through Grayscale's Horizen Trust ( OTCQX:HZEN ) shares. HZEN is one of the few Grayscale funds that still trades at a premium to net asset value. However, there is a slight concentration concern with HZEN. Not only do related parties own 3.6 million of the 6.8 million outstanding HZEN shares, but Grayscale currently has just under 605k of the 13.8 million ZEN in circulation sitting in the fund. Figures in millions AUM CMC Grayscale owns Ethereum Classic ( ETC-USD )( ETCG ) $229 $2,700 8.48% Horizen $5.5 $117 4.70% Bitcoin ( BTC )" target="_blank">OTC:GBTC ) $19,290 $589,610 3.27% Ethereum ( ETH-USD )( OTCQX:ETHE ) $5,820 $228,810 2.54% Livepeer (LPT-USD)( LPT )" target="_blank">OTCQB:GLIV ) $2.7 $131 2.06% Sources: CoinGlass, CoinMarketCap In the table above, I'm showing Grayscale fund AUM and the total market capitalizations for the underlying assets. In the far right column, we can see a rough estimate for how much of a coin's circulating supply is owned by Grayscale. At nearly 5%, the only coin that is more concentrated to Grayscale than Horizen is Ethereum Classic. Without organic demand for ZEN, the price of the token is going to continue to experience pressure as Grayscale takes its management fee from the HZEN fund and liquidates ZEN to pay itself. Privacy's "Top 3" I recently covered Zcash for Seeking Alpha back in May , and I'd encourage you to read that article as well for a more ZEC-focused assessment. At the time, I believed the bottom was likely in on ZEC and that has proven to not be the case. A major development for Zcash, since that article was published, was the late-May announcement that Electric Coin Company would be laying off about half of its staffers. Electric Coin Company, or ECC, is the lead developer of Zcash. Roughly two weeks after that announcement, ZEC had fallen another 30% from $31 down to $21. It has since recovered back to the mid $30's. Data by YCharts The reduction in ECC's workforce could possibly be viewed as a bit of a make or break moment ZEC. If ZEC has a future, it's going to require the broader Zcash community stepping up and decentralizing the network development. Dash is facing headwinds as well. About a month before the ECC announcement, as part of a lawsuit against crypto exchange Bittrex, the SEC alleged that DASH is an unregistered security. In my view, it's difficult to justify that allegation given DASH lacks many of the characteristics that are often common among the SEC's other unregistered security declarations. For instance, DASH is a proof-of-work coin that had no ICO and that has a large level of decentralization judging by retail holdings and mining pool distribution. DASH is far more like BTC than it is like MATIC - the latter of which the SEC believes to be a security while BTC gets a pass. Nevertheless, DASH is down about 40% since the Bittrex lawsuit in April. Data by YCharts 2023 hasn't been without an element of drama for privacy coin leader Monero either. Though XMR is holding up far better than peers. In what could possibly be viewed as an attempt at piggybacking the Ordinals phenomenon on Bitcoin, a user in the Monero community launched the Mordinals NFT project on Monero earlier this year. Like Ordinals before it in the Bitcoin community, Mordinals has come with a considerable amount of pushback from within the Monero community. That pushback has varied from justifiable concern about privacy degradation to outright disgust at what some have alleged to be a deliberate attack on the network under the guise of an NFT project. Data by YCharts Despite the presence of NFTs on the Monero blockchain, XMR had a strong June and at one point rattled off 13 consecutive green daily candles between June 15th and June 27th. XMR has unquestionably held up better than other privacy coins in the market over the last 12 months and the currency commands a $3 billion market cap and a crypto market cap rank of 26 according to CoinMarketCap. Investor Takeaways Privacy isn't just normal, it's necessary. It's required for both individuals and businesses in a truly free society. And privacy also happens to be a major drawback in using most distributed ledger technology as currently constructed. If tokenization is going to reach any kind of critical mass with self-sovereignty embedded for the participants, privacy solutions are required. Whether this privacy comes from base layer utility or network-native applications remains to be seen. We know mixers like Tornado Cash are not going to be tolerated by most regulators. Privacy coins were a very unloved segment in crypto a year ago. I'd argue they're even less loved today. These coins are battling exchange delisting, regulatory headwinds, and consumer apathy. These headwinds have led to Horizen dropping privacy as a network feature entirely. I maintain privacy on-chain is one of the great challenges facing the entire industry. My personal pick is still Zcash. But Monero is winning for a reason and that could certainly continue given the strength of the community that champions that network.