One of the bigger trends in the blockchain world, particularly when it comes to financial services and specifically capital markets operations, has been a need for privacy and confidentiality in the course of daily business. This has meant that blockchain solutions are being designed with this primary need in mind. This has led to all the private blockchain solutions being developed today.

When you build for privacy and confidentiality there are tradeoffs that come with that. Mainly you lose transparency, which was the major feature of the the first blockchain: bitcoin. As originally designed, a blockchain is a transparency machine. In this system, the computers are distributed and no one entity controls the network. Not only this, but anyone can be a validator and anyone can write to or read from the network. Clients and validators can be anonymous and all the data gets stored locally in every node (replication). This makes all transaction data public.

The security of bitcoin is made possible by a verification process in which all participants can individually and autonomously validate transactions. While bitcoin addresses the privacy problem by issuing pseudonymous addresses, it is still possible to find out who's addresses they are through various techniques.

This is the polar opposite of what is happening in the private blockchain world, where decentralization and transparency are not deemed as necessary for many capital markets use cases.

What is important is privacy and confidentiality, latency (speed) and scalability (able to maintain high performance as more nodes are added to the blockchain). Encrypted node-to-node (n2n) transactions mean only the two parties involved in the transaction receive data. In many of these systems there are opt ins for third party nodes (regulators) to be a part of the transaction.

Other systems being developed for similar purposes, which have been written about on this blog, have one designated block generator which collects and validates proposed transactions, periodically batching them together into a new-block proposal. Consensus is provided by a Generator that applies rules (validates) agreed to by the nodes (chain cores) to the block and designated block signers.

In these systems, decentralization is simply not necessary because all the nodes are known parties. In private blockchains the nodes must be known in order to satisfy certain regulatory and compliance requirements. The focus has been on how to preserve privacy and confidentiality while achieving speed, scalability, and network stability. Therefore, there are ways for legal recourse even between parties who don't necessarily trust each other.

What are cryptography and encryption?

As noted above with privacy and confidentiality being pivotal, encryption has become a major focus for all blockchains. Many of these solutions are using advanced cryptographic techniques that provide strong mathematically provable guarantees for the privacy of data and transactions.

In a recent blog post titled "A Gentle Reminder About Encryption" by Kathleen Breitman of R3CEV, she succinctly provides a great working definition:

"Encryption refers to the operation of disguising plaintext, information to be concealed. The set of rules to encrypt the text is called the encryption algorithm. The operation of an algorithm depends on the encryption key, or an input to the algorithm with the message. For a user to obtain a message from the output of an algorithm, there must be a decryption algorithm which, when used with a decryption key, reproduces the plaintext."

If this encryption uses ciphertext to decrypt this plaintext, you get homomorphic encryption and this (combined with digital signature techniques) is the basis for the cryptographic techniques which will be discussed in this post. Homomorphic encryption allows for computations to be done on encrypted data without first having to decrypt it. In other words, this technique allows the privacy of the data/transaction to be preserved while computations are performed on it, without revealing that data/transaction. Only those with decrypt keys can access what exactly that data/transaction was.

Homomorphic encryption means that decrypt(encrypt(A) + encrypt(B)) == A+B. This is known as homomorphic under addition.

So a computation performed on the encrypted data when decrypted is equal to a computation performed on the encrypted data.

The key question being asked is: How can you convince a system of a change of state without revealing too much information?

After all, blockchains want to share a (change of) state; not information. On a blockchain, some business process is at state X and now moves to state Y, this needs to be recorded and proved while preserving privacy and not sharing a lot of information. Furthermore, this change of state needs to happen legally, otherwise there is a privacy breach.

Cryptographic techniques like zero knowledge proofs (ZKPs), which use different types of homomorphic encryption, separate:

1) reaching a conclusion on a state of affairs

2) the information needed to reach that state of affairs

3) show that that state is valid.

The rest of this post will discuss how the trend towards privacy has led to cryptographic techniques, some old and some new, being used to encrypt transactions and the data associated with them from everyone except the parties involved. The focus will be on Zero Knowledge Proofs, zk SNARKs, Hawk, confidential signatures, state channels and homomorphic encryption.

The privacy problem on a blockchain is the main gap for deployment for all of the cryptographic solutions talked about below.

Outside of a blockchain, there are examples of homomorphic encryption in practice. CryptDB is an example of system that uses homomorphic encryption and other attribute preserving encryption techniques to query databases securely. It is used in production at Google and Microsoft amongst other places.

It does have limitations though: you have to define the kinds of queries you want ahead of time and it is easy to leak data. CryptDB provides confidentiality for data content and for names of columns and tables; however CryptDB does not hide the overall table structure, the number of rows, the types of columns, or the approximate size of data in bytes. One method CryptDB uses to encrypt each data items is by onioning. This allows each data item to be placed in layers of increasingly stronger encryption.

Gregory Maxwell designed a cryptographic tool (CT) to improve the privacy and security of bitcoin-style blockchains. It keeps the amounts transferred visible only to participants in the transaction. CT's make the transaction amounts and balances private on a blockchain through encryption, specifically additively homomorphic encryption. What users can see is is the balances of their own accounts and transactions that they are receiving. Zero knowledge proofs are needed to demonstrate to the blockchain that none of the encrypted outputs contain a negative value.

The problem with Confidential Transactions is that they only allow for very limited proofs as mentioned above. zkSNARKs and Zero Knowledge Proofs (ZKPs) which will be described in detail below, allow you to prove virtually any kinds of transaction validation while keeping all inputs private.

Zero Knowledge Proofs (ZKPs) are not new. They were first conceptualized in 1985 in a paper "The Knowledge Complexity of Interactive proof Systems". A ZKP is a cryptographic technique which allows two parties (a prover and a verifier) to prove that a proposition is true, without revealing any information about that thing apart from it being true. In the case of cryptocurrencies and blockchains this will generally be data about transactional information.

A zero-knowledge proof must satisfy three properties:

The first two of these are properties of more general interactive proof systems. The third is what makes the proof zero-knowledge."

A zk-SNARK (zero-knowledge Succinct Non-Interactive Arguments of Knowledge) is a Zero Knowledge proof that is a way to prove some computational fact about data without revealing the data. Zk-SNARKs are the underlying cryptographic tool used in Zcash and Hawk both of which are building blockchains with ZKPs and both will be explained later. In the case of Zcash these SNARKs are used for verifying transactions and in the case of Hawk they are used for verifying smart contracts. This is done while still protecting users privacy.

A zk-SNARK is a non-interactive zero-knowledge proof of knowledge that is succinct and for which proofs are very short and easy to verify. They can be thought of as little logic circuits that need to generate a proof of statement to verify each and every transaction. They do this by taking a snapshot of of each transaction, generate a proof and then need to convince the receiving side that the calculation was done correctly without revealing any data except the proof itself. The basic operation of a SNARK execution is a coded input into this circuit which can be decrypted.

Since zk-SNARKs can be verified quickly, and the proofs are small, they can protect the integrity of the computation without burdening non-participants. It should be noted that this technology is just now starting to mature but still has limitations. They are very CPU intensive to generate proofs and it takes up to 1 minute to generate new proofs, so scaling is still an issue that needs to be resolved.

The very first data points for zk-SNARKs will be Zcash which is a combo of distributed state and proof that you own the assets.

Zcash can be described as an encrypted open, permissionless, replicated ledger. A cryptographic protocol for putting private data on a public blockchain. Zcash can be thought of as an extension of the bitcoin protocol. Basically Zcash added some fields to the bitcoin transaction format to support encrypted transactions.

Zcash uses SNARKs (ZKPs) to encrypt all of the data and only gives decryption keys to authorized parties to see that data. This could not be done on a public blockchain until now because if you encrypted everything in the past it would prevent miners from checking to see if transactions are valid. ZKPs have made this possible by allowing the creator of a transaction to make a proof that the transaction is true without revealing the sender's address, the receiver's address and the transaction amount.

Zooko describes this by saying bitcoin has 3 columns, which are the three mentioned above (sender address, receiver address, transaction amount) and Zcash has 4. The 4th column proof doesn’t know the sender address, the receiver address and amount transferred, but it does know that nobody could have created the proof that comes with the encrypted values unless they have a secret key which has sufficient value to cover the amount amount being transacted. This is a proof that the data inside the encryption correctly satisfies the validity constructs. This allows the prevention of double spends and transactions of less than zero.

Zcash is mostly the same as bitcoin. The miners and full nodes are transaction validators. Zcash uses POW that has miners checking ZKP’s attached to each transaction and getting a reward for validating those transactions. Full nodes are the same except that if you have the private keys you can detect if some transactions have money that is there for you. SNARKs make it so that miners can reject a transaction from someone if their private key doesn’t have enough money for that transaction.

By keeping all data private except for the 4th column it omits information from leaking onto a private blockchain which allows for everyone to view information about transactions. zCash has selective transparency while bitcoin has mandatory transparency. This means that Zcash can reveal specific things to specific people by permissioning. It reveals specific transactions that anyone looking at them can verify in the blockchain.

Some differences from the zCash whitepaper include:

"Value in Zcash is carried by notes, which specify an amount and a paying key. The paying key is part of a payment address, which is a destination to which notes can be sent. As in Bitcoin, this is associated with a private key that can be used to spend notes sent to the address; in Zcash this is called a spending key.

A payment address includes two public keys: a paying key matching that of notes sent to the address, and a transmission key for a key-private asymmetric encryption scheme. “Key-private” means that ciphertexts do not reveal information about which key they were encrypted to, except to a holder of the corresponding private key, which in this context is called the viewing key. This facility is used to communicate encrypted output notes on the block chain to their intended recipient, who can use the viewing key to scan the block chain for notes addressed to them and then decrypt those notes.

The basis of the privacy properties of Zcash is that when a note is spent, the spender only proves that some commitment for it had been revealed, without revealing which one. This implies that a spent note cannot be linked to the transaction in which it was created."

Zcash is what's known as a decentralized anonymous payment schemes (DAP schemes). A DAP scheme enables users to directly pay each other privately: the corresponding transaction hides the payment’s origin, destination, and transferred amount.

In Zcash, transactions are less than 1 kB and take under 6 ms to verify — orders of magnitude more efficient than the less-anonymous Zerocoin and competitive with bitcoin. However the privacy achieved is significantly greater than with bitcoin. De-anonymizing bitcoin has become much easier through services that track and monitor bitcoin movements and the data associated with it. Mixer services allow for coins to be changed as they move through the system via a central party but this still is not sufficient enough.

The zCash whitepaper states:

"[M]ixes suffer from three limitations: (i) the delay to reclaim coins must be large to allow enough coins to be mixed in; (ii) the mix can trace coins; and (iii) the mix may steal coins. For users with “something to hide,” these risks may be acceptable. But typical legitimate users (1) wish to keep their spending habits private from their peers, (2) are risk-averse and do not wish to expend continual effort in protecting their privacy, and (3) are often not sufficiently aware of their compromised privacy."

The major motivations for ZKPs and the Zcash protocol are 1)privacy and 2)fungibility. Fungibility is being able to substitute individual units of something like a commodity or money for an equal amount. This can be a real problem when some units of value are deemed less because they are considered "dirty". Hiding the metadata history doesn't allow for a coin with a bad history to be rejected by a merchant or exchange. Gregory Maxwell said "Insufficient privacy can also result in a loss of fungibility--where some coins are treated as more acceptable than others--which would further undermine Bitcoin's utility as money."

Zcash is expected to launch soon and with that the genesis block of the Zcash blockchain. This will allow, like the bitcoin blockchain anyone in the world to mine, for Zcash. It will be an open, permissionless system (fully decentralized). Users will be able to send it to anyone using zero-knowledge privacy.

ZCash’s use of cutting edge cryptographic techniques comes with substantial risks. A cryptographic attack that permits the forging of zero knowledge proofs would allow an attacker to invisibly create unlimited currency and debase the value of Zcash. Attacks of this kind have been found and fixed in the recent past. Fortunately, the metadata hiding techniques used in Zcash tread are more production-hardened and can be considered less risky.

Andrew Miller in his whitepaper: "Hawk: The Blockchain Model of Cryptography and Privacy-Preserving Smart Contracts" has developed a programmable smart contract system which works in much the same way as zCash for smart contracts.

Hawk does not store financial transactions on the blockchain and keeps private the code of the code of the contract, data sent to the contract and money sent and received by the contract from the public. It is only the proof that can seen and all other useful information is hidden. Like zCash, transparency is selective in Hawk and wouldn't need to be used by all smart contracts but based on use cases and the preferences of the parties involved. It also aims to tackle the isssues of privacy and fungibility in much the same way as the zCash protocol.

The Hawk whitepaper does a great job of describing the motivation for contractual security it seeks to provide for financial transactions:

"While on-chain privacy protects contractual parties’ privacy against the public (i.e., parties not involved in the financial contract), contractual security protects parties in the same contractual agreement from each other. Hawk assumes that contractual parties act selfishly to maximize their own financial interest. In particular, they can arbitrarily deviate from the prescribed protocol or even abort prematurely. Therefore, contractual security is a multi-faceted notion that encompasses not only cryptographic notions of confidentiality and authenticity, but also financial fairness in the presence of cheating and aborting behavior."

According to Andrew Miller, Hawk is based on several cryptographic primitives. It uses the same zero knowledge proof library as zCash, which is called libsnark. Hawk also uses custom implementations of a lattice-based hash function, and public key encryption. Hawk uses a jSnark tool which is open sourced.

In Hawk, each party generates their own secret keys. Miller stated that: "For each contract, there is also a trusted public parameter, similar to Zcash. The only way to generate these parameters is a process that involves generating a secret value in an intermediate step, which needs to be erased at the end of the protocol. To borrow Zcash's term for this, it's like a "toxic waste byproduct" of the setup procedure, and like all industrial waste, it must be securely disposed of. There are many options... we could do what Zcash does and use a multi-party computation to generate these parameters, simply let a trusted party do it (the trusted party only needs to be used once and can go offline afterwards), or use trusted hardware like SGX."

Miller has said there are some differences between Ethereum contracts and Hawk contracts. Unlike Ethereum, the input language for private contracts in Hawk is C code. A private Hawk contract is not a long running stateful process like an Ethereum contract, but rather a 1-shot contract that proceeds in phases, where it first receives the inputs from each party, and then it computes the outputs for each party. After the outputs are computed, the contract is finished and no longer holds any balance. So, it is a slightly different computing model. Hawk supports both private contracts as described above, as well as public contracts which are exactly like those in Ethereum. (No privacy guarantees are provided for the public contracts, though).

As in Zcash, there are some challenges to blockchain scaling and optimizing cryptographic schemes so they are efficient when using ZKPs. Hawk tries to do as much computation off chain as possible. This is done because in public blockchains on chain computing gets replicated to every node and slows things down dramatically. Producing the proof can take up to several minutes (which is long) and can be costly. Nodes checking the proof only take milliseconds to do that. Data from the whitepaper: In Hawk, it takes about a minute of CPU time for each participant in a Hawk contract. On chain computation takes about 9 to 20 milliseconds.

Hawk has not announced a release date yet as they are still working on optimizing their snark compiling tools to enhance performance.

State channels allow for a payment channels that are off chain and allow for updates to any type of applications that have a change of state. Like the Lightning Network, two or more users can exchange payments that would normally require a blockchain transaction without needing to publish them on the blockchain or wait for confirmations except when setting up or closing out the channel.

Vitalik Buterin explains this in his paper for R3CEV "Ethereum Platform Review"

"State channels are a strategy that aims to solve the scalability challenge by keeping the underlying blockchain protocol the same, instead changing how the protocol is used: rather than using the blockchain as the primary processing layer for every kind of transaction, the blockchain is instead used purely as a settlement layer, processing only the final transaction of a series of interactions, and executing complex computations only in the event of a dispute

State channels are not a perfect solution; particularly, it is less clear how they extend to massively-multi-user applications, and they offer no scalability improvements over the original blockchain in terms of its ability to store a large state size – they only increase de-facto transaction throughput.

However, they have a number of benefits, perhaps the most important of which is that on top of being a scalability solution they are also a privacy solution, as the blockchain does not see any of the intermediate payments or contracts except for the final settlement and any disputes, and a latency solution, as state channel updates between two parties are instant - much faster than any direct on-blockchain solution, private or public, possibly could be, and potentially even faster than centralized approaches as channel updates from A to B can be secure without going through a centralized server."

State channels aim to address the scalability issues, privacy issues and confirmation delays associated with public blockchains while allowing actors who don't necessarily trust each other to transact.

For many people all of these cryptographic methods which mask all of the transactional data will come as a surprise. The blockchain is supposed to be a transparency machine in which anyone can join the network and as a result view all information on that network. Even in private blockchains, there is a more open view into the data then the protocols that have been mentioned in this post.

Another question which might come to mind is if consensus is even needed, since everything is private but the proof. If the proof is only between the two parties involved in the transaction why is consensus needed and why use a public blockchain. It may seem counterintuitive, but the answer is that yes a public blockchain is needed and so is consensus and its due to the privacy of the proofs. Essentially, complete transparency is needed to maintain the privacy of the proofs.

ZKPs and blockchains complement each other. You can't just use one to replace the other. A blockchain is used to make sure the entire network can agree on some state which may or may not be encrypted. ZKPs allow you to be confident about some properties of that state. In this scenario, you still need a canonical source of truth. A view key that reveals all incoming transactions but not outgoing ones. In order for this to happen, you need a fully decentralized ledger with consensus where everyone agrees with the data written there.

For example, Zcash has data which contains information which is useless and unreadable to most actors. It’s a database of commitments and opaque pieces of data. It's just a way to synchronize data between actors. (Zooko Wilcox has publicly stated that if Chainalysis graphed this out it would just be a series of timestamps of when a transaction occurred.) In cases where the number of transactions are low, then timing attacks could reveal the originator of transactions, imagine this to be equivalent of just one node connected to a Tor network.

The real emphasis is on the wallet side for actors because this allows them to spend money and move assets around, in bitcoin you can take a private key and move bitcoin. Now it's more. It’s a private key and a set of secrets you keep to prove previous proof and generate a new proof that you use to convince others. For this, a fully decentralized ledger is needed with consensus where everyone agrees with the data written there.

A blockchain is necessary because you need consensus layer from everyone: It is necessary to have an agreement of proofs in the ledger to move assets around later on, if that proof isn’t available in every node then you can’t convince anyone of the proof when you need to move assets later on. These proofs need to be stored in an open way so the proofs can be seen as being verified and accepted by receiving parties.

There are two different layers: 1) Needs to be agreement on what proofs everyone accepts 2) Needs to be agreement on what you can prove and what happens on proof of zero knowledge and what happens once you know the information.

How do you generate proof and pass that information to the next person? The key is to get authority of the transaction by adding a proof or metadata to the transaction with some type of conditional script (if then statements for transaction acceptance). This code contains transaction validity rules. A person sees proof from outside but they don’t know if the rule itself has been triggered or not.

Now that have you privacy from ZKPs, in order to comply with the transaction, you need to prove that the transaction abides by the rules. So you can take 2 proofs and create new proofs that the person receiving them can point at and verify that the proof is accepted by the entire network. Once the proofs have a meaning to you based on the rules, you can agree they were proved in the past and can be used in the future to transact and transfer money.

ZKPs are moving out of the realm of theory and becoming production strength. Now is the time to see how practical they are. They are only now going to start having really world tests and they still suffer from big scalability issues.

The work of developing a proof is enormous and has massive computation costs. As mentioned before, in Zcash in order to create a proof you move money from someone else it takes between 45 seconds and 1 minute on a really strong computer. Presently, people are working on making SNARKs and ZKPs more efficient by allowing for more proofs per second or for more elaborate proofs in the same amount of time.

Deep changes need to be made architecturally in DLT’s- understand knowledge of ZKP architecture need to understand the constraints of what you can prove and at what scale.

This article was previously published on the author's blog and has been republished here with permission.

Disclosure: CoinDesk is a subsidiary of Digital Currency Group, which has an ownership stake in Zcash. 

Locks and keys image via Shutterstock