Public Good, Personal Yield: How hTokens Enhance Privacy in DeFi
Imagine being able to transact and store assets on-chain without revealing your identity. Shielded pools make this possible through a set of smart contracts that enable anonymous transactions.
Imagine being able to transact and store assets on-chain without revealing your identity. Shielded pools make this possible through a set of smart contracts that enable anonymous transactions. However, there's a catch: users who contribute to the anonymity set often don't receive adequate incentives for their participation.
The Public Good Nature of Anonymity
In Shielded Pools, the level of anonymity provided to participants is directly tied to the pool's total value locked (TVL). When users add their assets to the pool, they increase the anonymity set, making it harder to trace individual transactions. This collective effort benefits everyone involved, but it also creates a problem: users who contribute to the anonymity set don't always receive compensation for enhancing privacy.
There are two key factors that affect the privacy provided by Shielded Pools:
1. The number of participants: As more users deposit their assets into the Shielded Pool, it becomes increasingly difficult to trace or guess the owner of a transaction.
2. The volume of the Shielded Pool: While the pool obfuscates transaction information, a large volume transaction can still reveal the identity of the transactor. A higher volume in the Shielded Pool reduces the probability of guessing the transactor's identity.
A healthy Shielded Pool requires a combination of a high number of participants and a substantial volume of transactions. However, building and bootstrapping a Shielded Pool often requires depositing assets that either sit idle or have limited yield opportunities. This can lead to a trade-off between privacy and profit, resulting in lower participation and reduced privacy for everyone.
Challenges and Solutions
There are three key issues with Shielded Pools:
1. Lack of Direct Compensation: Users don't receive direct rewards for enhancing the anonymity set, leading to low participation.
2. Free-Loader Problem: Some users benefit from the anonymity provided by others without contributing, which can diminish overall privacy.
3. Limited Yield Opportunities: Participating in Privacy Pools limits access to yield opportunities across DeFi, reducing capital efficiency.
To address these issues, we need to redesign the process of providing anonymity as a public good. We can do this by unlinking individual incentives from the need for privacy, allowing liquidity providers to contribute to Shielded Pools without necessarily needing privacy themselves.
Introducing hTokens - the liquid privacy tokens
Hinkal's Shared Privacy Ecosystem introduces a novel solution to these challenges through the concept of Anonymity Staking. By allowing users to stake their ERC-20 tokens into Shielded Pools and receive hTokens in return, Hinkal effectively aligns individual incentives with the public good of privacy for everyone.
Here's an example of how this works:
- Paolo wants to swap 10 ETH, while Suliko wants to send 1 ETH. With a total of 11 ETH in the Shielded Pool, Paolo's anonymity is compromised, but Suliko enjoys a higher level of privacy. This is the public good provisioning problem: Paolo provides a public good but can't benefit from it.
hTokens solve this problem by introducing a liquid privacy token that allows permissionless participation in Shielded Pools. Users who don't need privacy can earn yield from private transactions, increasing the size of the Shielded Pool and enhancing overall privacy.
How it Works - Anonymity Staking
Users stake their chosen collateral tokens into the Shielded Pool smart contract, receiving hTokens in return. These hTokens are tokenized representations of the staked collateral and can be used across various DeFi applications. The staking process involves locking up the deposited assets within the pool, increasing the amount of Shielded Pool participants and enhancing the privacy effect.
Conclusion
Hinkal's Shared Privacy Ecosystem revolutionizes DeFi privacy through the concept of Anonymity Staking. By aligning individual incentives with the public good of privacy, Hinkal creates a mutually beneficial Shared Privacy Ecosystem that encourages participation and enhances overall privacy. With hTokens, users can enjoy liquidity in Shielded Pools while contributing to the public good of anonymity.
In our previous blog post, you can learn more about the upcoming Hinkal V2 release.
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