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VeradiVerdict - Issue #108

Pantera is an early investor in Zcash, and I believe there has been significant progress made on the business development, community, and governance.

  • Bitcoin provided a powerful model for how cryptocurrencies could enable better security, privacy, and decentralization for financial transactions. However, it still faces significant limitations in the privacy and anonymity guarantees it can offer to users, meaning that it cannot fully realize the vision of a completely user-controlled financial system.

  • ZCash is a fork of Bitcoin that provides stronger guarantees on user privacy, by allowing for private transactions between parties. ZCash has two address types –– shielded (z-addresses), which mask transaction balances, and public (t-addresses), which expose transaction balances. Users can use shielded addresses to support private transactions, where no transaction metadata (including sender, recipient, and balance) is publicly exposed. To achieve these guarantees, ZCash uses a cryptographic tool called zk-SNARKs, which are zero-knowledge, succinct, non-interactive arguments of knowledge.

  • Given ZCash’s strong privacy guarantees, there’s been an explosion of interest in how the currency can better support various use cases across the crypto community. For example:

    • The total amount of ZEC held in shielded (private) addresses, has nearly doubled in the past year, demonstrating that users are opting into private asset management.

    • Gemini launched a feature to allow users to withdraw and deposit from shielded addresses into their Gemini account, meaning that exchanges are leveraging ZCash’s power to enhance their users’ privacy.

    • Various interoperability projects, like the Ren Protocol, are investigating wrapped token models for ZEC to help support ZCash in transactions with Bitcoin, Bitcoin Cash, Ethereum, etc.

  • Like Bitcoin, the supply of ZEC is also limited to be 21 million units. ZEC is minted into existence as a reward for miners on ZCash’s proof-of-work protocol; every four years, the reward for these miners is set to halve. The first halving (from 6.25 ZEC to 3.125 ZEC) is slated for this November and will likely boost the value of the asset and assuage concerns surrounding its inflation rate. Most importantly, it demonstrates that ZCash maintains many of the same monetary assurances that Bitcoin offers, and thus, is a powerful, versatile financial asset.

  • The ZCash community is also focusing on less centralized governance, and better community-driven support. The ECC, which developed ZCash, donated their body to the Bootstrap non-profit, where they will continue to develop ZCash, but align their incentives more strongly with that of the broader ZCash community.

  • Ultimately, ZCash is a powerful model for a versatile financial asset that provides extremely strong guarantees surrounding security, privacy, and anonymity. After a year of immense growth in terms of ZCash-oriented features and assets stored in shielded addresses, the upcoming halving event will further legitimize ZCash as a useful financial asset. More projects will begin to leverage ZCash’s economic and privacy guarantees to support further growth and use cases across cryptocurrency.

Taking Privacy a Step Further

The launch of Bitcoin was a major first step in bringing privacy, anonymity, and decentralized security to financial transactions. For the first time, users could send and receive money without having their transaction history documented on a centralized public ledger, where a centralized third party can tie them back to each transaction. By pseudonymizing transactions and decentralizing the financial system, Bitcoin provided a powerful model for maintaining privacy, in a decentralized, community-governed financial ledger.

Nonetheless, the original Bitcoin model has several cryptographic and technical limitations that prevent users from accessing complete privacy. For instance, the Bitcoin blockchain still stores the payer and payee addresses for each transaction; if one can map an address to a certain individual, they could theoretically scrape the blockchain to identify all transactions made to/from that individual. Additionally, since transaction amounts are disclosed (in the form of UTXOs), these amounts can often help observers infer where money was sent, or how it was handled, compromising some of the privacy benefits. Bitcoin’s consensus algorithm and storage schema is also quite slow, which bottlenecks the speed and volume of transactions that the network can support.

As crypto discovers more use cases around privacy-first financial systems, it’s critical that the community devise new models that resolve some of these concerns around pseudonymity, and leverage new research and cryptographic techniques to further mask transaction metadata, while keeping it publicly verifiable.

What is Zcash?

Zcash is a cryptocurrency specifically designed to preserve as much user privacy as possible. Zcash is a fork of Bitcoin, that unlike Bitcoin, permits private transactions between parties. More concretely, Zcash supports transactions to and from two types of addresses: shielded (which begin with ‘z’) and public (which begin with ‘t’). Public addresses reveal the balance of the transaction, whereas shielded addresses keep the transaction balance private, adding even more security. To verify details on shielded addresses, users can share special viewing keys with relevant parties to explicitly grant them access to that information, rather than it being publicly listed on the ledger.

Fig 1. Zcash Transactions. A shield represents a shielded address, while a circle represents a public address. (Source)

Zcash meets the three core requirements of Bitcoin (no double-spending, explicit authorization by payers, and a transaction’s input must equal its output), while providing stronger guarantees on privacy. To do so, Zcash leverages a cryptographic technique called a zk-SNARK, or a non-interactive zero-knowledge proof, that can efficiently and succinctly prove knowledge of some information, without exposing any of that information in the process. This enables zk-SNARK to verify the validity of private transactions, without requiring that that data be plainly exposed on the blockchain.

Additionally, since Zcash can powerfully mask transaction history, it makes all of its token fungible –– this means that all parties in a transaction treat all Zcash tokens as equal, irrespective of their transaction history. This is because unlike with Bitcoin, transactions aren’t fundamentally tied to UTXOs (which are tied to a transaction history); rather, each ZEC token can be treated as independent and generic, which more closely resembles how fiat cash is used today.

The Growth of Zcash

Given these privacy guarantees, Zcash has the potential to enable dozens of new financial applications that can protect consumer data, including use cases around cryptocurrency to pay for sensitive costs like medical bills, supply chain payments, and more. As a result, there’s been an explosion of interest around obtaining and using Zcash for a plethora of applications.

In the past year alone, the amount of Zcash stored in shielded addresses has nearly doubled, indicating that users are increasingly opting into private transaction types that preserve more anonymity and security around transaction metadata, like balance, sender, and recipient. Given that Zcash is one of the only existing cryptocurrencies that can support these security guarantees, we’re likely to see further growth in the amount of shielded ZEC as users identify more use cases for private transactions. Broadly, this also demonstrates that there’s a pressing need for decentralized verification of private transactions/computations on the blockchain; better primitives to support these kinds of computations (like zk-SNARKs) can enable dozens of applications beyond a pure financial system like Zcash.

Fig 2. Zcash Transactions Over Time. The number of shielded transactions has almost doubled over the past year. (Source)
Fig 3. Shielded ZEC Over Time. The size of the pool of all shielded ZEC continues to grow.

Given the rise in user interest, crypto exchanges are also stepping up to support better user experiences with Zcash. Gemini launched a feature that enables user withdrawals from Zcash shielded addresses, the first exchange to do so. In Gemini accounts, ZEC is stored in public t-addresses; the feature supports users withdrawing ZEC from a t-address into a z-address, or depositing ZEC from a z-address to this t-address in their Gemini account, giving them more flexibility over how they manage their funds. This is particularly interesting, since exchanges are often thought of as the most “centralized” thing in crypto –– by building out features to support more private forms of money management, Gemini helps supports a broader trend towards decentralization by giving users more control over their privacy.

The crypto community has also broadly been investing in infrastructure to support blockchain interoperability, and transactions that span multiple different protocols and token types. As more and more cryptocurrencies get launched, it’s imperative that we develop a way to transact BTC, ETH, USDC, etc. cleanly. Many protocols accomplish via “wrapped tokens,” which are essentially ERC-20 tokens that symbolize another asset (e.g. wBTC represents BTC), where the wrapped token is identical in value with the asset it represents, either implemented via smart contract or via backing the wrapped token with the underlying asset 1:1. Many protocols are investing significant effort in building wrapped tokens for Zcash for use on Ethereum and other blockchains. The Ren Protocol, a popular interoperability solution, is beginning by interfacing Bitcoin, Bitcoin Cash, and Zcash on Ethereum. Wrapped Zcash (WZEC) is another wrapped token representing Zcash, launched by Wrapped, a partnership between Tokensoft and Anchorage.

The fact that interoperability efforts are placing extra consideration on Zcash demonstrates that Zcash solves a real unmet need in enabling private transactions, across a plethora of financial use cases. Moreover, as these wrapped tokens and interoperability protocols become more robust, it becomes easier for users to leverage Zcash in any kind of DApp they build, meaning that the benefits of shielded addresses can be easily applied to a diverse number of use cases, spurring even more Zcash growth. Along with interoperability, the community is making a concerted effort towards building scalability into the blockchain as well. Halo 2 is a popular Zcash-oriented project that uses zk-SNARKS for efficient, compact computation via recursive proof composition, which makes transactions lighter and faster, and removes the need for a trusted setup.

Long story short, the community is deeply invested in building the experiences and abstractions necessary to “mainstream” Zcash in the crypto sphere. As users discover more and more applications for its privacy guarantees, the use of Zcash will grow exponentially, and support a more privacy-preserving financial paradigm in crypto.

Halving

Since Zcash is a fork of Bitcoin, the supply of ZEC is constrained in a manner similar to the constraints on Bitcoin. The total supply of ZEC is capped at 21 million tokens. ZEC is minted into existence as a reward for miners for mining Zcash transactions via the proof-of-work algorithm.

The reward given to miners is set to halve roughly every four years, in order to make ZEC a disinflationary asset and to also limit the amount of ZEC that will be mined into existence. The first halving event of ZEC will take place in November 2020, where the block reward will be halved from 6.25 ZEC to 3.125 ZEC.

The upcoming halving event reiterates that Zcash, like Bitcoin, is a finite-supply monetary asset, which can provide much of the same monetary and economic assurances as Bitcoin, which is much more of a mainstreamed crypto asset. Additionally, one perennial concern with Zcash has been its abnormally-high inflation rate; the upcoming halving event will essentially slash this rate in half by halving the block reward, helping mediate long-standing concerns around Zcash’s inflation. Zcash traders are also likely to see some volatility and/or jumps in price surrounding the halving event, which should stabilize in a couple of weeks, much like it does during Bitcoin’s halvings.

Decentralizing Governance

Since Zcash is able to provide such strong guarantees around user privacy, its often heralded as one of the best cryptocurrencies in terms of decentralization and anonymity. To help achieve that goal further, the stakeholders that manage Zcash are making a concerted effort towards more less centralized governance.

The Electric Coin Company (ECC), which is responsible for the development of Zcash, announced in October that they unanimously voted to donating the ECC to Bootstrap, a 501(c)(3) non-profit that leverages technology to uplift humanity. The idea behind the donation is to better align the development incentives of Zcash with tangible, beneficial ways of supporting more financial freedom and access. This structure enables ECC to maintain its “startup” team structure and efficiently build out further capabilities, while also providing more decentralized governance and better aligning incentives with the broader Zcash community’s goals. The ECC has also donated the Zcash trademark to the Zcash Foundation, another independent non-profit that focuses on building better financial privacy on Zcash. The Foundation will also receive 5% of block rewards to help support further projects.

The Zcash community also elected a Major Grants Review Committee, consisting of 5 members with backgrounds from the Ethereum Foundation, the Open Privacy Research Society, various Zcash protocols, and more. The Committee will govern the Major Grants Fund and use it to review and support various projects that leverage Zcash’s capabilities. Following the November halving event, the Major Grants Fund will earn 8% of all mining rewards for the next 4 years, building up capital to support dozens of projects in the Zcash space.

Final Thoughts

Privacy and anonymity continue to be huge value propositions for the broader blockchain and crypto community. Zcash presents a promising model for how users can use cryptocurrency for private, truly anonymous transactions, while still maintaining the economic and security guarantees of Bitcoin. The recent explosion of interest in Zcash, from the doubling of ZEC stored in shielded addresses, to the launch of Zcash-specific features on popular exchanges, to proposals for wrapped Zcash for cross-chain transactions, demonstrates how Zcash fulfills an important niche around enhanced user privacy.

The upcoming halving event in November is another reminder of the financial power of Zcash; the halving will likely boost the value of ZEC while controlling its inflation rate, making it a more usable store of value in the years to come. Efforts to better support the Zcash community, including donating the ECC and appointing a committee to allocate project grants, will spur even more growth in the ways that Zcash can be used as a legitimate financial asset. Ultimately, Zcash sets the stage for a much more privacy-oriented paradigm in crypto, helping enable dozens of more use cases.

- Paul V

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ABOUT ME

Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing in blockchain companies and cryptocurrencies. The firm invests in equity, pre-auction ICOs, and cryptocurrencies on the secondary markets. I focus on early-stage investments and share my thoughts on what’s going on in the industry in this weekly newsletter.