The idea of a decentralized internet, driven by blockchain technology, has always promised a future where privacy and control over data lie firmly in the hands of users. Yet, the Web3 space has been held back by one critical issue: the lack of on-chain confidentiality. Today, blockchain’s public nature means that anyone can view transactions, wallet addresses, and sometimes even sensitive details. This transparency has fostered innovation but also creates an environment where true privacy is hard to come by. As we shift further into Web3, balancing privacy and compliance becomes key to enabling real-world applications that are both useful and safe.
The Growing Demand for Confidentiality in Web3
Blockchains are often described as “trustless” because they do not require users to trust any centralized authority. However, they are also public—anyone can view transaction data, even if wallet identities remain pseudonymous. While this level of transparency has its benefits, particularly for regulatory oversight and auditability, it has also created significant challenges.
Consider the scenario of a company wanting to pay its employees using a blockchain-based system. With current infrastructure, every payment is visible on-chain. The company cannot hide the salaries or bonuses it pays, nor can it prevent competitors from analyzing its financial strategies. Similarly, individuals making charitable donations or personal payments on the blockchain are exposed to potential scrutiny or even harassment. This lack of on-chain privacy has hindered the adoption of blockchain technology for many practical, real-world use cases.
While privacy might once have been dismissed as a tool for bad actors, it is now widely recognized as a necessity for any functional, mainstream application of blockchain technology.
Why Confidentiality is Misunderstood in Web3
Privacy in Web3 often gets a bad reputation. On one end of the spectrum, it’s associated with illicit activities like money laundering. On the other, it offers valuable use cases such as private financial transactions, confidential AI applications, dark pools for trading, healthcare data management, and more.
The financial markets offer a useful comparison: confidentiality can make information valuable and tradable, but selective disclosure is essential to prevent market abuse. This balance between transparency and confidentiality is vital for economies to function efficiently. The same principles apply to Web3. While confidentiality is often viewed suspiciously due to fears of illegal financial activities, it is also the key to unlocking high-value use cases like private payments, frontrunning protection, dark pools, and even private governance for DAOs.
The Role of Selective Disclosure in Web3
Selective disclosure in Web3 is emerging as a solution to the privacy problem. It allows users to choose what information to reveal and when, ensuring that privacy and compliance can coexist. Selective disclosure involves using cryptographic tools to share specific pieces of information while keeping other details hidden.
1. Pre-Transfer Proof of Funds
One promising approach is the use of pre-transfer proofs to ensure that funds are legitimate before a transaction is executed. Projects like Railgun and Privacy Pools enable users to prove that their funds are not linked to illicit activities without disclosing additional private information. This system offers an important balance, providing compliance with financial regulations without sacrificing user privacy.
2. Post-Transfer Selective De-Anonymization
In certain scenarios, selective de-anonymization can be applied post-transaction. This process balances privacy with accountability, ensuring that users’ identities remain private unless a valid legal request for disclosure is made. Zero-Knowledge Proofs (ZKPs) and threshold cryptography are key to enabling this feature. For instance, a user’s identity might remain anonymous unless their transaction triggers a regulatory concern. In such cases, authorities could request de-anonymization, which would require multiple parties (such as DAOs or trusted validators) to agree to decrypt the information.
Balancing Privacy and Compliance
The tension between privacy and compliance is not unique to Web3. In traditional finance, confidentiality is a norm, not an exception. Banks, financial institutions, and even large tech companies manage highly sensitive data while ensuring compliance with regulations. The challenge for Web3 is to find a way to replicate these privacy protections while maintaining the decentralized nature of the system.
To address this, we must rethink how privacy and compliance interact in decentralized systems. Zero-Knowledge Proofs (ZKPs), Multi-Party Computation (MPC), and Decentralized Identity (DID) frameworks offer mechanisms for verifying information without revealing it. These techniques enable Web3 projects to remain decentralized while offering the privacy necessary for real-world adoption.
For example, an individual could prove they have enough funds to participate in a financial transaction without revealing the amount or source of their assets. Similarly, companies could conduct payroll or B2B payments without exposing confidential details to the entire blockchain.
Decentralized Compliance Solutions: A Path Forward
In traditional finance, compliance measures are centralized—banks, financial institutions, and regulators ensure that anti-money laundering (AML) and know-your-customer (KYC) requirements are met. However, the decentralized nature of Web3 poses a unique challenge: How do you enforce compliance without introducing centralization?
1. Threshold Cryptography for Post-Transaction Audits
Threshold cryptography can play a significant role in enabling privacy while still allowing for compliance. In this system, no single party can access private information. Instead, multiple parties, known as Revokers and Guardians, must agree to decrypt a user’s transaction if there’s a valid legal reason. The transparency of the system ensures that any requests for de-anonymization are publicly verifiable, protecting users from unwarranted breaches of privacy.
2. Decentralized Identity (DID) and Smart Contracts for Compliance
Decentralized identity (DID) systems can help regulate transactions by allowing users to share necessary identity details only when needed. With DID integration, users can meet KYC or AML requirements through smart contracts that enforce rules such as transaction limits or geographical restrictions, while still keeping other aspects of their identity private.
This approach allows Web3 platforms to ensure that their users comply with regulations without relying on centralized authorities. Compliance becomes embedded in the system itself, ensuring both privacy and regulatory adherence.
Applications of Confidentiality Beyond Finance
Confidentiality in Web3 isn’t just about financial transactions. The ability to maintain privacy while still enabling compliance has applications in multiple industries:
1. Frontrunning Protection and Dark Pools
Confidentiality can protect traders from frontrunning—where others exploit transaction data to place orders before them in financial markets. By hiding transaction details until after they are completed, confidentiality protocols ensure a fairer trading environment. Dark pools, already used in traditional finance, enable traders to execute large orders anonymously, preventing market manipulation. The decentralized version of dark pools, powered by blockchain technology, can achieve the same effect without centralized control.
2. Gaming and PvP Markets
In gaming and prediction markets, confidentiality can be crucial for fair gameplay. Imagine a blockchain-based prediction market where users submit predictions. By using confidentiality protocols, users’ predictions can remain hidden until the results are revealed, ensuring fairness and preventing manipulation. Similarly, in decentralized gaming, hiding certain moves or actions until necessary can add layers of strategy and excitement.
3. Confidential AI and Healthcare
Confidentiality is especially important in sectors like healthcare and AI, where sensitive data must be protected. In healthcare, blockchain-based systems can store patient records while only allowing access to authorized parties, ensuring privacy and compliance with regulations like HIPAA. Similarly, AI models can be trained on private data without exposing sensitive information, unlocking new possibilities for innovation without compromising privacy.
A Seamless Future for Confidentiality in Web3
For Web3 to truly take off, confidentiality must become seamless and user-friendly. Just as HTTPS has become the standard for internet security, privacy in Web3 must be integrated into every layer of the system—so seamlessly that users hardly notice it. The shift toward multimodal cryptography—which combines ZKPs, MPC, and threshold networks—can create this seamless experience.
The vision for Web3 is clear: a future where privacy is not an afterthought but a built-in feature. With the right tools and frameworks, we can build a decentralized internet that ensures user privacy, protects data, and meets regulatory requirements—all without compromising the ideals of decentralization.
This balance is not just possible—it’s necessary.