The burgeoning popularity of Ethereum Layer 2 platforms has been one of the key success narratives in the blockchain space over recent years. As Ethereum has attempted to make itself more scalable, L2 networks have been working in lockstep to develop solutions that can overcome legacy issues of scalability and privacy. Zero-knowledge (ZK) encryption has been one of the key enabling technologies, but can it live up to the continued weight of demand for confidential on-chain applications? 

The reality is that ZK encryption has established valuable use cases, but it has limitations. Broadly, ZK technology is designed to deliver a straightforward solution to one problem – how one party can prove a fact to another party without revealing the nature of the fact itself. 

This feature has enabled some important developments in the blockchain environment. It enables scalability via transaction bundling and has applications for secure transactions involving identity. For instance, a ZK solution could allow someone to validate that they are above a legal minimum age without disclosing their date of birth or any identifying features. 

However, privacy in this one step does not guarantee privacy in any other element of the transaction, such as the purchase itself or anything involving the execution of an online smart contract. This explains why many of the often-touted use cases for blockchain have taken so long to come to fruition. For example, on-chain voting in the context of DAOs was one of the original use cases cited in the Ethereum white paper in 2014. Ten years on, any truly private on-chain voting system has yet to launch. 

In Search of the Holy Grail

For many years now, FHE, or fully homomorphic encryption, has been established as the “holy grail” of online confidentiality.  FHE is the only holistic solution enabling end-to-end computation of encrypted data from multiple sources, introducing true privacy for users. Discovered in the late 1970s, it has only been in practical use since around 2009. 

One of the original visionaries compared the process to the boxes with gloves that reach inside of the kind often seen in chemistry labs for handling toxic chemicals. Everything takes place in a sealed environment, so nothing inside the box is ever exposed to the outside world, but the gloves provide a means of handling the contents safely and securely. 

However, this level of encryption comes with challenges. For a long time, FHE was thought to be too computationally intensive to deliver any real-world utility. However, developments are now allowing it to be brought to its full potential. 

Fhenix is one example, leveraging decentralization to support the computational load involved. Fhenix is an Ethereum Layer 2 platform that allows developers to incorporate FHE into their smart contracts, offering full transaction confidentiality. 

The project uses a network of “co-processors” which allow the offloading of computational tasks from the host chain. This approach dramatically improves the efficiency of FHE operations to a level where it can be used in an everyday consumer application while maintaining the same security as the host chain. 

Unlocking New Utility

The advancement of FHE to a point where it can be used in everyday applications opens up a host of new use cases for blockchain, such as confidential transactions that are also fully auditable, offering an assurance of regulatory compliance with rules covering privacy and data protection. 

DeFi also offers plenty of low-hanging fruit for FHE use cases. It allows users to keep their account details and transaction history fully confidential, eliminating the likelihood of attackers identifying a potential target through their on-chain wallets. A platform like Fhenix can also offer better MEV (maximum extractable value) protection since it allows users to hide their transaction details so that they can’t be exploited by validators or miners seeking to extract more profit by selectively ordering transactions. 

Ultimately, improvements in confidentiality and security will make DeFi more appealing to institutions, increasing trust and adoption of blockchain technology.  

FHE also facilitates confidential on-chain operations such as voting and auctions. DAOs can choose to offer members the option to make anonymous proposals, and vote confidentially, which could make a significant difference in circumstances where changes are creating controversy among members. Furthermore, the ability to demonstrate robust privacy measures over individual data is likely to make DAOs more appealing to prospective members. 

Even with the pace of advancement over recent years with ZK encryption and now FHE, it’s worth bearing in mind that there is still plenty of scope for further improvement as the technology develops. Over the coming years, we can anticipate that FHE will become more scalable and efficient while more use cases of on-chain encryption will drive further innovation.