Bitcoin layer 2 Statechains gaining recognition as the reality of privacy erosion sets in

On August 8, the U.S Treasury added Tornado Cash to its Office of Foreign Assets Control (OFAC) list. Officials alleged that the crypto mixer was used to launder over $7 billion of crypto tokens since its inception in 2019.

This included over $455 million in tokens stolen from the Axie Infinity Ronin bridge hack, which North Korean-affiliated Lazarus Group claimed responsibility for. And the Harmony bridge heist, in which hackers netted a total of $96 million.

Since then, several third-party vendors moved to sever their ties with Tornado Cash, including Circle, which blacklisted the company’s USDC wallets. The net result of sanction compliance saw the platform shutter its operations.

There is a fear that the U.S. government is deliberately targeting privacy-focused crypto projects by ramping up its regulatory efforts. In doing so, personal freedoms and the right to privacy may be further eroded.

However, a variety of Bitcoin developers, including Mercury Wallet developer Nicholas Gregory, have been working on transaction privacy for some time. While their work remains relatively unnoticed, the actions of the U.S. Treasury in sanctioning Tornado Cash have inadvertently thrown a spotlight on this area.

Bitcoin is an open ledger

Bitcoin transactions are publically viewable and permanently stored on the ledger. Bitcoin addresses are pseudo-anonymous, meaning the only information tagged to them is the flow of transactions.

But, once an address is used, it “takes on” the history of all transactions that have interacted with that address.

While this setup doesn’t directly reveal one’s identity or personal information, off-ramping, usually done at a centralized exchange with KYC requirements, will link transactions to a person. Non-KYC P2P marketplaces exist, but the exchange rates are generally unfavorable compared to CEXs.

Privacy experts often recommend using a Bitcoin address only once. However, as most wallets do not offer a perpetual address feature, the practicalities of using a single burn address for every transaction are unrealistic for most average users.

Crypto mixers offer a degree of privacy by mixing traceability between users, thus obfuscating direct transaction flows. However, a great deal of trust is placed in the mixing service not scamming users or keeping transaction records.

Privacy is being eroded

With crypto adoption growing over time, scant consideration has been paid to the monitoring and censorship of personal transactions. Since…