Myth of Money: Zero-Knowledge Proofs and Roll-Ups Explained
Welcome to this week’s edition of Myth of Money, a weekly newsletter on the digital asset markets read by 10,000+ investors.
Disclaimer: The following is not intended as investment advice. Do your own research.
Dear Investors,
Events over the past few weeks have highlighted the gap between reality and the decentralized ideal we often paint in the crypto industry.
Many people welcome the recent identification of the bad actors behind the DAO hack and the Bitfinex heist while condemning the Canadian government for using similar tactics to identify vaccine protestors and freeze their wallets.
Privacy can benefit two opposite extremes - people and businesses who want to keep their private dealings…well, private on the one hand, and criminals and hackers on the other. Privacy concerns, along with scalability, are two of the biggest obstacles to growing the utility and therefore user adoption of crypto. One of the most promising technologies for the improvement of these shortcomings are zero-knowledge proofs.
What is a Zero-Knowledge Proof?
A zero-knowledge proof (ZKP) is a method of cryptography whereby one party (the “prover”) convinces a counter-party (the “verifier”) that something is true, without sharing any information beyond “This is true.” In this barebones description, the statement “This is true” is a placeholder for any number of more specific statements. It could mean “I know the password” without actually sharing the password; “I have this information” without sharing the information; “I am the proper recipient of this transaction” without sharing your identity, and so on. The word “proof” is a bit of a misnomer, though; ZKP rests on the idea that the probability that the statement is actually false is so low that it’s practically (but not literally) zero.
Some examples of a zero-knowledge proof:
Tree Leafs: I want to convince you that I know how many leaves are on a given tree, but I don’t want you to know how many leaves there actually are. Without my seeing, you either pluck a leaf off the tree, or you don’t. Then I simply tell you whether you did or did not pluck a leaf, and we repeat this until the credibility of my knowledge is sufficiently established. Notice here how convincing you doesn’t require you to count the total number of leaves. This is a good illustration of how ZKP can not only increase privacy, but also help to simplify the process of verification.
Ball Color: You are colorblind and you have two balls; one is red and the other green, but otherwise they are identical. I want to convince you that the balls are different colors, but I don’t want you to know which ball is which. You place the balls behind your back and show me the one in your right hand. Then, without me seeing, you either switch the two balls, or you don’t, and again show me the one in your right hand, at which point I tell you whether you switched them or not. Again, we can repeat this process until you are sufficiently convinced that I know the balls are different colors, but you otherwise gain zero knowledge about the balls.
The above examples are simplistic, “real-world” analogs to the encryption and decryption processes that in practice take place digitally. These examples also require interaction between the two parties. But important innovation is underway that enables non-interactive ZKP, which is steadily making its way into crypto.
How can zero-knowledge proof be applied to crypto?
Increased Privacy: By minimizing the amount of information that is published to the blockchain without compromising the verification process of the transactions, ZKP can increase privacy. To date, the most notable example of incorporating ZKP into the blockchain is Zcash, which built upon Bitcoin’s codebase and added in a layer of ZKP to strengthen anonymity. Developers are also currently working on incorporating ZKP into the Ethereum blockchain. This work is all the more pressing considering the advent of quantum computing, which could make hacking current blockchain protocols much easier.
Enhanced Scalability: One proposed solution to the blockchain’s throughput issues, which limit the speed and volume of transactions it can process, is a so-called rollup. As Vitalik Buterin has written: “Rollups…are a ‘hybrid’ layer 2 scheme…(that) move computation (and state storage) off-chain, but keep some data per transaction on-chain.” The idea is that by moving some of the data off the blockchain, the computing and storage requirements decrease, meaning the speed and volume of transactions can increase. Zero-knowledge roll-ups are one of the two primary types; Vitalik has predicted that as the technology improves, it will become the dominant method.
Both applications of ZKP have issues. Critics have questioned whether Zcash’s privacy claims are airtight and Zcash has faced regulatory concerns regarding its anti-money laundering standards. Rollups, meanwhile, are very early-stage and face significant challenges, including low integration into crypto wallets.
As recent events have shown, there is plenty of work to do for crypto and blockchain to live up to their promise. ZKP has the potential to truly enable people to work together without needing to trust one another. It is therefore an important piece of the puzzle.
Further Reading
This Week By the Numbers 📈
Bitcoin’s 60-day correlation with equities reached a record high this week, per Bloomberg, casting further doubt on its role as a hedged asset. Despite geopolitical uncertainty surrounding Russia’s invasion of Ukraine, prices remained steady on the whole as investors await seeing how strong economic sanctions will be and how that may ripple across the economy.
Top Stories 🗞
FTX Takes Aim at the $300 Billion Luxury Goods Market and Hires a Beauty Entrepreneur to Head the Push
Crypto exchange FTX has hired a former model-turned-beauty entrepreneur to onboard luxury brands to crypto. The move signifies the three-year-old, $32 billion company’s ongoing grasp for consumer mindshare, following such steps as launching a gaming division, splurging on a Super Bowl ad, and purchasing the naming rights of the Miami Heat’s stadium. Examples of luxury brands that have already entered crypto include Prada, Ralph Lauren, and Gucci.
Foundation Focused on UST Stablecoins Raises $1B in LUNA Sale
Luna Foundation Guard, the Singapore-based nonprofit behind the Terra ecosystem and its native UST stablecoin, announced a $1 billion fundraise to establish a foreign-exchange reserve denominated in Bitcoin. The reserve “is an initiative to provide a further layer of support” for the stablecoin. The group is also behind the Luna token, sales of which provided the funding. Jump Crypto and Three Arrows Capital led the round, with participation from DeFiance Capital, Republic Capital, GSR Ventures, and Tribe Capital among others.
Manchester City to Build Etihad Stadium in the Metaverse
“The celebrated soccer team has begun the initial stages of building its iconic home stadium in the metaverse so fans can be part of live and recorded matches around the world.” The move comes on the heels of Man City’s rival Manchester United announcing a partnership with Tezos as its official crypto partner.
Former Cisco Employee Launches DAO to Buy Denver Broncos
“The next owners of the Broncos could be a humble DAO organized by a group of professionals who may wind up paying the most ever for a North American sports team.” BuyTheBroncosDAO is aiming to raise $4 billion to purchase the NFL franchise and give fans a chance to own part of the team.
Coinbase Says Revenue Tops Estimate, Cautions on Trading Volume
In its 2021 fourth-quarter earnings report, the publicly traded crypto exchange showed higher-than-expected revenues, but saw share prices slump 3% that day on tepid expectations for the first quarter of 2022. “We believe that retail monthly transacting users and total trading volume will be lower,” the company wrote in a letter to investors.
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Thank you for reading this week’s edition of the Myth of Money.🚀
Until next week,
By Tatiana Koffman
Hi there and thanks for reading. If you stumble upon my newsletter, you will notice that I write about money, economics and technology. I hold a JD/MBA and spent my career in Capital Markets working across Mergers & Acquisitions, Derivatives, Venture Capital and Cryptocurrencies. I believe in empowerment through closing the financial education gap and creating equality of opportunity for the next generation.
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