SeDe: Balancing Blockchain Privacy and Regulatory Compliance by Selective De-Anonymization

Abstract: Privacy is one of the essential pillars for the widespread adoption of blockchains, but public blockchains are transparent by nature. Modern analytics techniques can easily subdue the pseudonymity feature of a blockchain user. Some applications have been able to provide practical privacy protections using privacy-preserving cryptography techniques. However, malicious actors have abused them illicitly, discouraging honest actors from using privacy-preserving applications as "mixing" user interactions and funds with anonymous bad actors, causing compliance and regulatory concerns. In this paper, we propose a framework that balances privacy-preserving features by establishing a regulatory and compliant framework called Selective De-Anonymization (SeDe). The adoption of this framework allows privacy-preserving applications on blockchains to de-anonymize illicit transactions by recursive traversal of subgraphs of linked transactions. Our technique achieves this without leaving de-anonymization decisions or control in the hands of a single entity but distributing it among multiple entities while holding them accountable for their respective actions. To instantiate, our framework uses threshold encryption schemes and Zero-Knowledge Proofs (ZKPs).