What Are Zero-Knowledge Proofs?
Zero-knowledge proofs (ZKPs) have the power to provide value to two key use cases: privacy and decongestion.
ZKPs are digital protocols that allow data-sharing between two parties without associating any information with the transaction, like passwords. By not passing the data around, it’s also possible to improve scalability.
ZKPs are also great for security, as no information from the sender or receiver can be compromised in any way. With this in mind, there are a few aspects to consider about the impact of this novel technology.
On the one hand, we are already immersed in the process of digitalization, as we are constantly entrusting more and more of our data to centralized third parties, like government agencies and Silicon Valley companies.
The more valuable the data we share, the bigger the incentive for bad actors to attack these central points of failure. This private data is extremely valuable and breaches are becoming more common, as this chart by Comparitech shows.
Enter blockchain technology. Blockchains bring a great degree of transparency to our digital economies, but having every transaction recorded on a public ledger presents privacy concerns and increases the amount of data circulating. Even though public addresses are a random grouping of numbers and letters, if an address is linked to a person or entity, then it’s possible for anyone to see all of their transactions, both past and moving forward.
Zero-knowledge technology is the missing part of the privacy puzzle. We do not need to have all our information transparent for the world to see. Instead, we could use a verification system to make sure that information is available to others without knowing what that information is via a zero-knowledge proof.
For example, zero-knowledge technology allows individuals, businesses and governments to verify data such as transactions and personal information or identification without handing over control of the information. This is a more secure way to verify information and relieves congestion by removing the need to send and store the information on Layer 1.
As the Ethereum network becomes more congested, the key use case of zero-knowledge technology will be its ability to drastically improve scalability and reduce fees associated with cryptocurrency transactions.
Why Is the Ethereum Network Congested?
The current version of Ethereum, or ETH 1.0, is based on a proof-of-work algorithm (PoW). PoW has proven to be a great way to increase security in decentralized protocols, but it is also very resource-intensive, as it needs a vast amount of computational power to function.
To operate in the Ethereum network, users need to pay fees depending on the type of transaction they are making. This fee is denominated in Ether (ETH) and is known more commonly as "gas."
Every time there is a demand for a popular decentralized application (DApp), like CryptoKitties in 2017 or the summer of decentralized finance (DeFi) in 2020, gas prices go up. Below is a chart showing the median gas price of Ethereum during 2020 by Interdax.
Think of it as Ethereum being a city with a limited capacity petrol station system and users are vehicles driving through the city’s streets. If many users decide to drive simultaneously, gas becomes more scarce and therefore more expensive.
One way to guess how capable decentralized networks are to scale is by comparing them to well-established, centralized payment networks, like PayPal and Visa.
There are many studies around, and the target number has been set to 2,000 transactions per second (TPS), which is the amount of transactions per second needed to compete with the likes of Visa. See the differences between traditional payment networks and major cryptocurrencies in the image below, by Crypto.com.
Why Is Zero-Knowledge Technology Important to Solve Congestion and Increase Scalability?
Ethereum is currently transitioning from PoW to proof-of-stake (PoS) and adding new core functionalities that will bring Ethereum 2.0 to life. The Ethereum 2.0 network will be able to scale significantly; however, this will take some time and we need to scale the current Ethereum as soon as possible.
Many teams are working in parallel on this by developing second layers on top of Ethereum. Below is the roadmap of the different upgrades being implemented during the transition from Ethereum 1.0 to Ethereum 2.0, by Ethereum.org.
In the context of distributed ledger technologies (DLT), layers refer to frameworks built on top of existing ledgers to increase their efficiency.
Integrating a second layer provides a place where transactions can be recorded and added to the ledger in batches or groups that prevent the network from getting clogged.
Layer 2’s are not limited to Ethereum. For instance, the Lightning Network is a Layer 2 on top of Bitcoin.
Nobody likes waiting a few minutes to transfer funds between wallets or making payments. Users demand instant-finality for their transactions, which is crucial if we are to achieve mainstream adoption of blockchain technologies.
How Does Zero-Knowledge Technology Work to Solve Scalability Issues?
Thanks to zero-knowledge proofs, we do not need to count every token transfer as a transaction. That’s where zk-rollups come in. With zk-rollups, we can batch hundreds or even thousands of token transfers into one transaction, which then gets recorded on the Ethereum public blockchain.
By squeezing many transactions into one, the fees and computer power are shared amongst hundreds or thousands of users. For example, this is how the Hermez zk-rollup batches up token transactions:
Zk-rollups rely on zk-SNARKs. They create a SNARK proof that can be used to refer to the transaction from the Ethereum chain. They also employ relayers to send funds deposited by a user to a smart contract.
Other proposed scalability solutions are optimistic rollups and sidechains. Optimistic rollups (OR) are quite popular due to their smart contract capabilities and the rise of DeFi.
OR do not rely on SNARK, and face a trade-off between finality and security. They do not suffer the complexity of using zk-SNARKs, but they compromise privacy and speed.
What Does Zero-Knowledge Technology Mean for the Future of Fintech and Decentralized Finance?
Zk-rollups have received much attention due to Vitalik Buterin and the Ethereum Foundation's support. Vitalik has written several pieces explaining his vision about rollups to scale Etherum now and how they could scale Ethereum 2.0 even more.
ZK technology has great potential to improve processes in many fields. For exchanges, the obvious benefit is increased margin in their operations, which could trickle down to benefit traders using their platform in the form of lower trading fees.
What Is Next for Zero-Knowledge Technology?
Amongst the more promising use cases for zero-knowledge proofs are chain voting models, verifying computation results and data auditing.
There are ongoing experiments of chain voting in the blockchain, commonly referred to as governance. Outside the blockchain world, there are great possibilities for increasing the legitimacy of political elections and corporate voting.
Zero-knowledge proofs can help increase the security and anonymity of voting processes, and lower the possibility of censorship. By moving the voting process to a public blockchain, eligible voters or shareholders can cast their ballot without revealing their identity, and they can claim verification of their vote to ensure their ballot was counted.
Another field of great potential is computational verification. As mentioned at the beginning of the piece, with more digitalization comes more data breaches. We are in a place where we need fast storing and access to data while maintaining individuals and institutions' right to privacy. Zero-knowledge technology could solve this dilemma by masking identities and using hashes to verify that the information and computations are legitimate.
Last but not least is the issue with data integrity and data availability, which are significant concerns for cloud storage services. Users upload personal data together with authentication information, making them relinquish ownership of their data. Data may face corruption, theft, loss or unauthorized purchase from a third party. Zero-knowledge technology can help with the data auditing process developing schemes to prevent data leakage.
Hopefully, this article will help you explore the potential of zero-knowledge technology. It’s quite a learning curve, and we are more than happy to walk it with you.