We’re pleased to announce our investment in the seed financing round of Nocturne, a next-generation protocol for private Ethereum accounts, along with our friends at Polychain and Bain Capital Ventures.
The Demand for Privacy
To understand Nocturne, let’s first discuss privacy. Historically in Web2, institutions have been accustomed to keeping their transactions and holdings private. There are basic principles of privacy that apply to TradFi companies and retail participants who value the privacy of their assets. For example, would you want your bank account information exposed to the public? Or for your wire transfer to be known to the world? Probably not.
We believe that having sufficient privacy is valuable in web3 as well. Many sophisticated institutions in web3 are well-aware that privacy via anonymous addresses is a “myth”. Firms such as Chainalysis or TRM Labs have proven that via intelligent analysis and clustering of addresses, you can effectively “de-anonymize” the blockchain and lift the veil of anonymity. Crypto trading firms in-particular are looking for privacy because they don’t want their competitors tracking their trades and are good examples of legitimate users. If their trades are exposed, they can be front-run or arbitraged.
The Status Quo for Privacy
The status quo of web3 privacy today isn’t great.
Prior attempts at privacy in web3 have largely been new financial protocols where the application-layer protocol itself is private. zCash, for example, was a privacy protocol that enables users to make payments privately. Other examples are up-and-coming “DeFi dark pools” which use zero-knowledge proofs to keep the trading private within that pool.
The drawbacks of creating privacy in the application-layer protocols is that they aren’t compatible with existing protocols. You can use a protocol for payments within that protocol, but what if you want to trade different assets or perform DeFi activities? Those actions aren’t private today. Users generally don’t want to be “constrained” to using a small subset of protocols that support privacy – they want to use the plethora of protocols that exist today.
Tornado Cash was an early attempt at privacy that boasted compatibility with existing protocols. Tornado Cash introduced a “remixing” service for tokens. The concept behind Tornado cash is to deposit tokens, split them into smaller buckets of tokens, combine those tokens with tokens from other users, and then withdraw at the back-end to a different address. As a result, you’re effectively obfuscating funds, but still get to use all of the well-known protocols.
The challenges with Tornado Cash are two-fold:
- It involves an “extra remixing step.” This isn’t great for UI/UX–it’s preferable to keep things simple for users.
- Tornado Cash prevented the US Government from tracing the flow of funds, making it difficult to catch criminals. As a result, it was used by illicit actors (e.g., the North Korean Lazarus Group) due to its anonymity. Tornado Cash grew to $7B in volume before being sanctioned by OFAC because it was being used by illicit actors.
Importantly, according to Chainalysis, 82% of the users of Tornado Cash were legitimate (not illicit) which points to a larger market of legitimate users. That legitimate demand is no longer being serviced. The absence of Tornado Cash has effectively left a glaring hole in the market for privacy. Could a better system be created that addresses the above concerns–a “better” alternative to Tornado Cash? If so, there’s clear market demand for such a solution.
What is Nocturne?
Nocturne solves some of the existing challenges with privacy in an elegant fashion. With Nocturne, the user accounts within the protocol are inherently anonymous. A simple way to think about Nocturne is that it creates “burner addresses” that are temporary in nature within the protocol each time a new transaction is made. Nocturne can be compatible with every major protocol, without having to retrofit or change those protocols. This makes Nocturne the most practical approach to privacy that we’ve seen.
Unlike Tornado Cash, Nocturne performs a background check using data from TRM Labs, and has other safeguards planned as well, for purposes of regulatory compliance. We believe addressing the regulatory issue is critical to prevent illicit actors from using privacy tools and web3 generally (and it’s rightfully a focus of US regulators and Congress).
Why is Nocturne Exciting?
We believe Nocturne represents the “holy grail” of privacy for several reasons:
- Since the privacy tech exists at the account-level, it’s compatible with all major DeFi protocols (don’t need to rewrite dApps, have special KYC’d pools, etc.)
- Users can select their privacy level and have it apply to “all DeFi”
- Nocturne doesn’t require an “extra remixing” step like Tornado Cash – which is a superior UI/UX
- Nocturne is architected from the ground-up to be compliant
Overall, we’re thrilled to partner with Nocturne because we fundamentally believe they’re building the right solution to the problem. We believe Nocturne has the potential to usher-in a new era for an easy-to-use, private, and compliant web3 financial system.
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