Balancing Blockchain Compliance with Privacy Concerns
20 Years of SFI—A Look behind the Scenes of World-Class Finance Research
As part of SFI's 20th anniversary celebrations, we are showcasing a selection of finance research conducted by SFI faculty members. Today, SFI ranks among the top 10 finance institutes worldwide. Each edition of our showcase features one SFI professor, presenting their research area, key insights, and the practical impact of their work.
At their core, these blog posts reflect what lies at the heart of SFI: fostering world-class research, advancing knowledge, and bridging research and practice—all contributing to the long term prosperity of Switzerland's financial marketplace and the country as a whole. SFI, growing knowledge capital for the last 20 years and in the years to come.
This edition features SFI Professor Fabian Schär from the University of Basel and his research on blockchain privacy and regulatory compliance.
SFI Professor Schär's research lies at the intersection of economics and computer science, with a particular focus on public blockchains, blockchain-based financial infrastructure, decentralized finance (DeFi) protocols, and financial privacy. Recent research on blockchain privacy has captured the attention of cryptocurrency users and regulators worldwide. Blockchain technology is known for its transparency and decentralization, but a desire for greater anonymity has led to the adoption of tools that pose a problem for regulators.
"On the one hand, if you have complete anonymity—with no chance of getting caught for illicit activity such as laundering money or evading taxes—there would be anarchy in the system. It seems noncontroversial to assert that there has to be a threshold beyond which police or regulators can hold wrongdoers accountable. On the other hand, you do not want a complete loss of privacy for users. The right balance lies between the two."
Offering a Path Forward that Balances Privacy and Compliance
Noncustodial crypto asset mixers such as Tornado Cash were developed in response to user concerns about privacy on the blockchain. These mixers combine potentially identifiable cryptocurrency funds with others, so as to obscure the trail back to the original source. Tornado Cash came under fire in 2022 when the US Department of the Treasury alleged it was being used for laundering by hackers and other malicious cyber actors.
SFI Professor Schär and coauthors wanted to explore a way of preserving the privacy of legitimate blockchain users while disincentivizing use by malicious actors. Their research introduced the concept of Privacy Pools. Privacy Pools allow regulatory compliance by enabling users to prove that their funds are not linked to illicit activity without requiring full transaction history disclosure.
Their contribution shows a path forward, where blockchain privacy and regulatory compliance are not incompatible. Challenges remain. In particular, the researchers warn against centralized access and systemwide entry "allowlisting", as both may generate quasi-monopolistic market structures.
"What we offer is a first step toward a solution. An acceptable solution will need to involve cooperation among finance practitioners, academics, policymakers, and regulators."
More Information
- Blockchain Privacy and Regulatory Compliance: Towards a Practical Equilibrium, (with V. Buterin, J. Illum, M. Nadler, and A. Soleimani)
- European Commission: Directorate-General for Financial Stability, Financial Services, and Capital Markets Union, Enhancing Financial Services with Permissionless Blockchains, Publications Office of the European Union, 2024.
SFI Prof. Fabian Schär (UNIBAS)
Fabian Schär is Professor of Distributed Ledger Technology (Blockchain) and Fintech at the University of Basel and a Faculty Member of SFI. In addition, he serves as the Managing Director of the University's Center for Innovative Finance. He has been appointed as a visiting lecturer by various central banks, a visiting scholar by the International Monetary Fund (IMF), and a technical advisor to the Committee on Payments and Market Infrastructures (CPMI) at the Bank for International Settlements (BIS). He has also authored a report for the European Commission on the use of public blockchains in a regulated environment. Professor Schär has been an invited speaker at over 100 events, including the G20, the IMF/World Bank Annual Meeting, and major conferences hosted by Central Banks, regulators and multinational institutions. Prior to joining academia, he worked as a consultant in various positions at banks and bank-related companies.
"What I appreciate about SFI is that it gives me an opportunity—through the SFI Master Classes, events, and panels—to connect to the private sector. The view from practitioners helps me look at my research from a different perspective and, complementarily, gives me a chance to share research with those outside of academia."