A Zero-Knowledge Proof Era: A rising trend in the making?

In today’s digital era where data privacy and security are paramount, financial institutions must strive to adopt innovative technologies while maintaining customer trust and regulatory compliance. Zero-knowledge proofs (ZKPs) could be the answer to this challenge. By using ZKP technology, crypto investors can retain privacy, while institutions can use it to bridge traditional capital onto public blockchains. At the same time, it can be also used as a powerful tool for blockchain scalability without compromising decentralisation. Could ZKP begin a new era of privacy-focused innovation?

Developed by MIT researchers in the mid-80s, zero-knowledge proofs (ZKP) are a cryptographic authentication technique that allows one party to prove possession of specific data without actually revealing it.

For instance, when applying for an apartment rental, an individual can use ZKPs to prove they meet the minimum income requirements without disclosing their financial records or social security numbers.

In every instance where ZKPs are applied, a “prover” generates mathematical proof that demonstrates they hold secret knowledge (in this case, the income statements), and the recipient, called the “verifier”, can confirm its validity without uncovering the secret.

Now this approach can be incredibly useful considering it protects personally identifiable information (PII) and allows individuals to prove their credentials without having this information sent and stored on centralised third-party services – which are especially vulnerable to hacks.

Versatile in application

ZKP technology is incredibly versatile when it comes to protecting data privacy. It can be applied to a variety of real world use cases, including identity protection, authentication, autonomous payments, scalability and decentralised voting, to name a few (see previous article).

In traditional finance, ZKPs are expected to gain popularity because financial institutions are hesitant to reveal private data on a public blockchain – not to mention both in terms of customer trust and as pertained to regulatory obligations. ZKP technology however allows them to keep their sensitive information secure, and at the same time, still enjoy the benefits of using blockchain technology.

ZKPs are also a versatile and powerful tool for improving blockchain scalability. The rise of zero-knowledge rollups, a Layer 2 (L2) scaling solution which can execute thousands of transactions off-chain, are especially important for networks like Ethereum, which have struggled with slow processing speeds, congestion issues and high gas fees (more below).

Why should investors care about ZKPs?

Investors should pay attention to the rising ZKP trend, particularly scaling solutions like ZK-rollups. In short, these rollups work by bundling multiple transactions into a single, large transaction, reducing transaction costs and increasing transaction throughout, while maintaining the security and privacy of blockchain technology. This is important because 1) it can help alleviate the blockchain trilemma by providing a solution for scalability without sacrificing security and decentralisation and 2) it can be a critical solution for remedying some of the industry’s biggest bottlenecks – scalability and faster, cheaper transactions.

This year, with the recent deployment of ZKP on Bitcoin, the launch of zkSync Era, and Polygon’s zkEVM, among several integrations of zkSync Era’s technology on major decentralised finance (DeFi) protocols like Aave, Uniswap, Chainlink and Maker, this technology shows no signs of slowing down.

ZKP technology is also gaining popularity among everyday users, with more than 90 percent of respondents in a recent survey finding cryptocurrencies using ZKPs more attractive. Even, the technology is explicitly mentioned in a US Treasury publication as a potential solution to support various AML/CTF obligations while maximising user privacy when using DeFi services.

Major financial institutions like ING and BBVA are actively working with ZKP technology, along with Ernst & Young’s Nightfall, a ZK-rollup that helps enable private transactions on the public Ethereum blockchain, which is expected to go live in May. The consulting giant also recently launched its beta version of Starlight, a compiler to help create zero-knowledge applications (zkApps) which can be deployed on-chain.

ZKPs could be a primary trend in the making, with ZK-rollups and Optimistic rollups competing as the leading Layer 2 (L2) solutions for the Ethereum blockchain. This fierce competition led to an all-time high in crypto assets locked in the L2 market sector this year.

A prime example of this trend was the release of zkSync Era, which attracted a total value locked (TVL) of over USD 230 million within just a few weeks after its launch.

Total Value Locked (TVL) in zkSync Era. Source: Dune Analytics

Arbitrum and Optimism currently lead the L2 market share but zkSync Era has already secured the third position, despite not having launched a token or airdrop yet (although it plans to do so soon). TVL locked in other ZK-rollups, like StarkNet, have also started to increase during the same timeframe.

Embracing a privacy-centric future

The rise of ZKP technology shows a promising future for bridging traditional financial systems with the ever-evolving realm of DeFi and public blockchains. But it is becoming clear that both traditional and crypto participants stand to benefit equally.

ZKP technology empowers businesses and consumers to adopt trustless technologies while retaining control over their sensitive data – which can be considered a sound method for balancing transparency and trust, with that of privacy and security.

With the launch of various ZKP initiatives, we see strong signs pointing towards a promising rise in the adoption of blockchain, especially among businesses and users who were once sceptical of its transparent nature.

This is a trend to keep a close and a steady eye on.

END

Disclaimer

This document is purely for educational purposes and has been issued by Sygnum Group. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication. It does not constitute an offer or a recommendation to subscribe, purchase, sell or hold any security or financial instrument. It contains the opinions of Sygnum Group, as at the date of issue. These opinions and the information contained herein do not take into account an individual's specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes personalized investment advice to any investor. Therefore, you must verify the above and all other information provided in the document or otherwise review it with your external advisors. Some investment products and services, including custody, may be subject to legal restrictions or may not be available worldwide on an unrestricted basis. The information and analysis contained herein are based on sources considered as reliable. Sygnum Group uses its best efforts to ensure the timeliness, accuracy, and comprehensiveness of the information contained in this document. Nevertheless, all information indicated herein may change without notice.