Blockchain technology started as an open-ware decentralized distributed ledger technology that records and validates transactions across multiple computers. One of its core strengths is transparency, which means anyone can access every transaction registered on the chain, mainly the address of parties and values involved.

Despite being an advantage to the ecosystem, transparency also poses a significant security risk to parties involved in blockchain transactions. It can lead to financial stalking and identity exposure, leaving users vulnerable to various cyber-attacks and even real-life attacks.

To this end, confidential transactions were developed as a cryptographic protocol to help protect the visibility of the identity and assets of users involved in transactions on the blockchain.

What is Confidential Transactions?

Confidential transactions are a cryptographic technology that adds an extra layer of privacy and security to transactions based on the blockchain. This allows for transaction details such as parties to a transaction and the amount of assets transacted to be concealed and made private while allowing the network to verify the validity of transactions effectively.

In the traditional blockchain system, details of transactions can be tracked publicly using tools such as Blockchair, Etherscan, Solscan, and 0xExplorer, leaving transactions and parties involved vulnerable to attacks. Through this system, cyber attackers would have unrestricted access to financial data and can analyze transaction patterns to exploit vulnerabilities.

With the advent of confidential transactions, information about transactions, such as the account details of parties involved and the amounts, is kept private to third parties. Despite this, the encrypted nature of the blockchain would still allow for the validity of transactions to be verified.

History of Confidential Transactions

Source: Epicenter

Adam Back, a Briton cryptographer and the inventor of Hashcash, noticed that the Bitcoin network is vulnerable to privacy and fungibility problems. Even though transparency and decentralization are advantages of blockchain, he saw that lack of privacy can also pose a significant threat to users.

To solve this, he proposed the concept of confidential transactions in an article he wrote on Bitcoin Forum titled “Bitcoin with homomorphic value” on October 01, 2023. In his treatise, he argued that blockchain transactions can be processed and validated without revealing the details to third parties.

The concept was further developed by Gregory Maxwell, a co-founder of Blockstream and a Bitcoin Core developer. He explored the technical aspect of confidential transactions and worked toward the real-life implementation of it in the Bitcoin ecosystem. In 2015, the pioneer practical confidential transactions were implemented on Blockstream’s Element Sidechain.

Cryptographic Techniques Used in Confidential Transactions

Source: EDUCBA

Several cryptographic techniques are used to achieve a confidential transaction-proof ecosystem. These techniques ensure that data are secured and that maximum privacy is maintained in blockchain transactions.

Pedersen Commitment

The Pedersen Commitment is a cryptographic technique that ensures a party to a transaction can commit to a value without revealing the details involved. While direct parties have access to the details of transactions, it is made private in the blockchain where its validity and integrity can be upheld. This method is used in privacy-focused systems to ensure data remains hidden but verifiable.

Ring Signature

Source: WallStreetMojo

A ring signature is a technique that allows members of a pool of signers to sign/validate transactions created within the group anonymously. Anyone from the pool can verify these signatures but cannot ascertain, specifically, the pool member who created the signature. This helps keep transactions private and untraceable since they can’t be traced to a particular individual.

Homomorphic Encryption

Source: HashedOut

Homomorphic encryption enables the blockchain to validate decrypted transaction data without decrypting the amount involved. This ensures that the users’ private information is concealed without revealing private/sensitive details.

Range Proofs

Source: Ventral Digital

Range proof is a cryptographic technique used for verifying values without revealing the exact data being verified. In confidential transactions, range proofs prove that the volume of assets being transacted falls within a particular range while the specific volume being transacted is kept secret.

For instance, the prover of a transaction first publishes a cryptographic commitment to a secret amount, which is the transaction amount. Pedersen Commitment is often used for this process and it conceals the necessary transaction details while ensuring that it can still be verified.

Thus, the prover demonstrates to the verifier that a committed value falls within a specific range, without disclosing the actual value. The verifier then checks the proof to confirm the validity of the transaction.

Bulletproofs

Source: Good Audience

Bulletproof is a range-proof cryptographic method that helps verify transactions without revealing the exact amount involved. Transactions are verified by proving that the amount lies above or below a certain range without specifying the amount involved while maintaining privacy in transactions.

Stealth Addresses

Source: IoTeX

Stealth addresses allow users to receive funds anonymously without revealing the exact address of the sender involved. For each transaction, a stealth address, which is a temporary, one-time address, is generated making it extremely difficult to track on-chain.

Schnorr Protocol

Source: Lucas Nuzzi

The Schnorr Protocol is a secure and efficient way to verify a signature without revealing sensitive information. Schnorr protocol allows for a signer to prove that they possess a private key corresponding to a public key. This is done without having the signer reveal the private key.

Diffie-Hellman’s Elliptic Curve (ECDH)

Source: HyperSense Software

ECDH is a cryptographic technique that allows the different parties in a transaction to share details of the transaction safely, even over insecure channels. It is used with Stealth Addresses and Pedersen’s Commitment to achieve data confidentiality on the blockchain.

How Does Confidential Transaction Work?

Source: Sunflower Corporation

Several cryptographic techniques are employed to execute a confidential transaction successfully. Below is the typical outline of processes involved in the process:

Hiding Transaction Amounts

When a transaction is initiated, the sender creates a Pedersen Commitment to make the transaction amount private.

Ensuring the Amounts are Valid

Bulletproof, a form of range-proof, is used to ascertain the validity of transactions. This is achieved by proving that the amounts involved fall within a specific range without explicitly revealing the amount involved in the process.

Masking the Recipient

To make the recipient anonymous, Elliptic-Curve Diffie-Hellman (ECDH) is employed to generate a one-time stealth address for the recipient, thus, preventing the direct association of the recipient to the transaction.

Verification Without Revealing Details

To complete the transaction, you need to verify it. This is often achieved with Ring Signature in a manner that doesn’t reveal the actual transaction amounts or the recipient’s identity involved.

Real-World Application of Confidential Transactions

Confidential transactions have been successfully implemented and used to process transactions with maximum privacy standards on the blockchain. Some of the major adopters of the technology include:

Confidential Transactions in Blockstream’s Element

Source: Blockstream

Confidential transactions were first implemented on Blockstream’s Element. Transactions on Element are completely discreet, with confidential transactions hiding the amount and the type of asset transferred.

It combines Pedersen’s Commitment, Bulletproofs, and a special “Federation of Signatories called Block Signers” who sign and create blocks efficiently and confidentially.

Confidential Transactions in Monero

Source: Monero

Monero (XMR) is one of the major cryptocurrencies whose transactions are untraceable and invisible on the blockchain because users are anonymous. Every detail relating to XMR transactions, including the sender, recipient, and the amount of asset transacted, is completely off the blockchain’s radar. Monero uses Stealth Addresses and Ring Signature technology to conceal transaction trails.

Confidential Transactions in MimbleWimble

Source: MimbleWimble

MimbleWimble is a blockchain protocol that limits the visibility of the amount transacted only to direct parties to the transaction, the sender and the recipient. MimbleWimble uses Homomorphic Encryption and Pedersen’s Commitment cryptographic techniques to achieve this. Some of the popular crypto projects available on the protocol are MimbleWimbleCoin (MWC), Grin (GRIN), Litecoin (LTC), and Beam (Beam).

Confidential Transactions in Liquid Network

Source: Liquid Network

Liquid Network, a Bitcoin sidechain developed by Blockstream, also obfuscates sensitive details of transactions, such as the addresses of the recipient and sender, the type of asset, and the amount involved. It is designed to promote confidentiality and fungibility of assets and is enhanced by the underlying cryptographic techniques, Pedersen’s Commitment and Bulletproofs.

Confidential Transactions in Zcash

Source: Zcash

Zcash is an open-source blockchain protocol, created on the original Bitcoin code base, that uses cryptographic techniques to encrypt transaction details and hide assets. Zcash primarily uses shielded addresses and zk-SNARK to achieve confidentiality for transactions processed on the protocol.

Shielded addresses use private addresses generated for the senders and recipients in a transaction to make them hidden on the blockchain. Zk-SNARK, Zero-Knowledge Succinct Non-Interactive Argument of Knowledge, allows for verification of transactions processed on Zcash without revealing sensitive information to third parties on the blockchain.

Benefits of Confidential Transactions

Confidential transactions have been useful in transmitting sensitive information on the blockchain, which is an open-source network, without revealing the details to third parties. This has been gaining traction in the blockchain industry due to its value to the ecosystem. Here are some of the core benefits:

Enhanced Privacy and Data Protection

Confidential transactions help protect data of transactions from external entities who can keep track of them from open source resources such as ledger books and exploit them for different reasons.

This also ensures that the fungibility of the crypto ecosystem is preserved because there won’t be a chance to flag the address or reject its activities. Thus, each user and coin has equal access and privilege in the ecosystem.

Increased Security

Confidential transactions help protect users from crypto-scammers who study transaction trends, wait to see a pattern, and exploit vulnerabilities.

Regulatory Concern

Some confidential transactions are designed to enable users to share transaction details with authorized persons for regulatory or auditing purposes without exposing all the information to the public.

Challenges of Confidential Transactions

Even though confidential transactions have been making strides in the decentralized ecosystem, there are still certain limitations associated with it.

Scalability

Because of the complex encryption and decryption process involved in confidential transactions, a very high computational power is involved, leading to a slower TPS (transaction per second). This can lead to blockchain congestion due to high computational demand, which can lead to increased transaction fees and slower confirmation time. These can also lead to a reduced adoption of the innovation by a larger percentage of crypto users.

Regulatory Concern

Confidential transactions can pose a major challenge to regulations and regulatory authorities since some aspects of the technology may threaten Anti-Money Laundering (AML) and Know-Your-Customer (KYC) policies.

Also, confidential transactions can be a fora that can be exploited for illegal financial activities, such as money laundering, terrorism financing, and tax evasion.

Complexity

Adopting confidential transaction infrastructure in blockchains can be technically complex because of the specialized knowledge involved in cryptography and blockchain development. It might require a lot of resources, such as expertise, time, and funding to create and integrate the infrastructure.

Conclusion

The future of transactions on the blockchain is gradually leaning towards privacy-enhanced infrastructure because the use case of confidential transactions transcends beyond the financial aspects of blockchain. It can also store and transmit sensitive information in healthcare, defense/military, supply chain, real estate, Internet of Things (IoT), and virtual economies.

While there are challenges to the infrastructure, the demerits would eventually be corrected with constant research by industry experts and enthusiasts, thereby unlocking the full potential of confidential transactions.