Imagine checking your account and discovering your money has been frozen. Not because of anything you did, but because of someone else’s illegal activity.
That is exactly what happened last month, when Circle, the company behind the world’s second-largest stablecoin (a digital cryptocurrency designed to always be worth one U.S. dollar) froze $12.6 million of its coins. Circle reportedly acted in response to a court order targeting illicit funds. But the freeze also trapped completely unrelated users, preventing them from using their own money.
Circle did not appear to target those users intentionally. The problem is the technology that Circle and other stablecoin issuers are leveraging: It’s impossible to cleanly separate lawful funds from illicit ones without catching innocent users in the crossfire.
This should alarm anyone who expects digital dollars and blockchain-based payments to become part of everyday finance. Banks, asset managers and payment companies are increasingly moving money and assets onto blockchains, the shared digital ledgers that underpin cryptocurrencies. But many of the systems they are adopting leave ordinary users exposed to sweeping, imprecise enforcement actions.
Institutions genuinely need a specialized way to use this technology: a mechanism that keeps sensitive financial details private while still allowing legal enforcement when necessary. But those capabilities should not come at the cost of freezing lawful users’ money over conduct they had nothing to do with.
Why Institutions Need Tailor-Made Technology
Traditionally, a blockchain is a public record of transactions. On networks like Bitcoin and Ethereum, anyone can look up activity and see how assets move from one address to another. That openness is one reason blockchains are useful. It allows people to verify transactions without trusting a bank, clearinghouse or central operator.
That same transparency creates an obvious problem for serious financial institutions.
A hedge fund cannot broadcast its trading strategy to the world. A bank cannot expose customer flows to competitors, analytics firms and criminals. A tokenized fund cannot reveal every investor and transfer to anyone with an internet connection. For regulated institutions, privacy is a legal and commercial requirement.
This is why banks and other large institutions have been drawn to privacy-focused blockchain systems. They want the speed and settlement benefits of blockchain without showing the entire market what they are doing. That is a reasonable goal. No serious version of institutional blockchain adoption can work if every trade, customer relationship and balance sheet movement is visible by default.
The problem is the design of the privacy systems many institutions are choosing.
Several blockchain systems have emerged, designed to keep transaction details private. Canton and Zama Chain are two popular choices among institutions. Although these networks make many concessions (and on a technical level, function more like a shared database than a blockchain), they provide institutions the advantage of keeping their actions partially secret.
But privacy changes how enforcement works. When the enforcement system assumes visibility of all transactions, institutions may lose the ability to act against specific illicit funds without harming everyone else in the same environment.
The Freeze Problem
Taking enforcement action against a specific user or transaction is a fairly routine responsibility for institutions and stablecoin issuers. They are often required to freeze funds in response to sanctions, hacks, fraud or court orders. But when institutions are using specialized protocols like Zama, performing a freeze is extremely difficult.
On a public blockchain, a stablecoin issuer can usually identify the visible address holding the asset. If a particular address is tied to illicit activity, the issuer can target that address. That is still a serious action, but it is at least specific.
Privacy wrappers make this impossible. When users deposit stablecoins into a private contract, the issuer may no longer see each individual user as the holder. The contract becomes the visible holder of the assets. If illicit funds enter that contract, the issuer may not be able to distinguish one depositor from another. One bad deposit threatens every lawful user in the same system.
That tradeoff is unacceptable for mainstream finance.
Innocent Users Will Pay the Price
This problem will become more severe as more traditional financial activity moves onchain.
Today, the most visible example is stablecoins. Tomorrow, the same issue could affect tokenized stocks, bonds, money market funds, private credit products and payment systems used by ordinary consumers. These products come with even more rules than stablecoins. Some assets can only be held by verified investors. Some can only move in certain jurisdictions. Some require restrictions based on sanctions, accreditation status or customer type.
If privacy systems make those rules impossible to enforce precisely, institutions will reach for blunt tools. They will freeze large swaths of transactions, block massive pools of users, and pause entire systems until lawyers, compliance teams and courts decide what happens next.
The people most exposed will be ordinary users who did nothing wrong.
Privacy Needs Precision
The answer is not to reject blockchain privacy. Institutions genuinely need privacy, and consumers often need privacy too. No one should have to expose their financial life to the open internet to use modern payment and settlement systems.
The answer is better privacy.
A well-designed system should allow institutions to keep sensitive transaction details private while still giving issuers, custodians and regulated venues the ability to enforce rules precisely. A stablecoin issuer should be able to comply with their regulatory obligations, including the ability to identify and freeze specific illicit funds. A bank should be able to apply KYC rules to its own customers. A regulated trading platform should be able to screen participants without making every transaction public.
That requires a different model: public-chain settlement, private execution, native assets and programmable compliance.
In plain English, the base financial rail should remain open, verifiable and neutral. Sensitive activity can happen privately above that base layer. Compliance rules can be built into the applications where the actual products are offered. Separating these processes into multiple layers allows institutions to protect customer information without catching stray users in the collateral damage when enforcement is required.
Thankfully, many people in crypto are already working on these tools. Zero-knowledge cryptography and other privacy technologies can allow parties to prove that rules were followed without exposing every detail of a transaction. That kind of design can give institutions the privacy they need and consumers the protection they deserve.
Privacy should protect lawful users. It should not put them in the blast radius.
Jan Philipp Fritsche is the founder of Bermuda, an enterprise-grade privacy protocol designed for EVM-compatible blockchains, which leverages state-of-the-art zero-knowledge cryptography to deliver private, compliant and gasless transactions without requiring changes to existing on-chain infrastructure.
