In the early days, Bitcoin was thought to be an anonymous and entirely untraceable digital currency. However, as the blockchain technology became more recognized by the public, it became apparent that the opposite is true. The blockchain, Bitcoin's public ledger that stores information about each and every transaction, is a remarkably rich source of information for both researchers and authorities.
Blockchain – Bitcoin's public ledger
The past and present ownership of every single Bitcoin is recorded in the ever-growing public ledger known as the blockchain. Blockchain is fully transparent and accessible to everyone. With the use of simple analytical tools, known as blockchain explorers, anyone can see how the coins are changing hands.
Bitcoin's receiving address is a unique string of letters and numbers. If you reveal your Bitcoin receiving address, then, thanks to the transparent blockchain, anyone who knows this address will be able to learn what the balance of this address is. And, if you re-use the same address to receive money from other users, then every one of them will recognize that the other users have sent you money.
For example, during the Silk Road bust, nearly 30,000 Bitcoins were seized and transferred to the following receiving address 1Ez69SnzzmePmZX3WpEzMKTrcBF2gpNQ55. Even though these coins were auctioned off by the US government and changed hands many times since then, you can still trace them using a blockchain explorer, such as Blockchain.com.
Consequently, unless you don't use privacy-enhancing methods or Bitcoin anonymization services, such as Tumbler, every Bitcoin can be traced back to your wallet.
Three pillars of Bitcoin anonymity
Unlike bank accounts, credit cards, and other payment systems, Bitcoin addresses are not directly tied to the real-world identity of users. Anyone can create a new, random address privately without the need to submit any personal information.
Additionally, Bitcoin transactions are not tied to the identity of users. Anyone can transfer Bitcoin from one address to another without revealing any personal information. As such, not even the receiver needs to know the identity of the sender.
Finally, transaction data is transmitted and forwarded by nodes to a random set of nodes on the peer-to-peer network. It's not necessarily clear for nodes whether the transaction data they received was created by the node they connect to, or if that node only forwarded that data.
So, is Bitcoin anonymous?
Unfortunately, no. Bitcoin is not anonymous—it's rather pseudo-anonymous. There are several dedicated privacy coins, such as Monero or Zcash, that are entirely anonymous. However, Bitcoin is not one of them.
Sending and receiving Bitcoins is similar to writing under a pseudonym. If the author's pseudonym is ever linked to their identity, everything they ever wrote under that pseudonym will now be linked to them.
In Bitcoin, the pseudonym is the Bitcoin address. If the address, or pseudonym, is ever linked to the real-world identity, all the past transactions could be traced back to this identity.
There are several ways to relate these addresses to real-world identities. Most notably, it's possible thanks to Know Your Customer (KYC) and Anti-Money Laundering (AML) policies.
Lawmakers around the world are introducing tighter regulations on crypto trading, making it practically impossible to buy or sell digital currencies anonymously without providing proof of ID. There are only a few options left—Bitcoin ATMs, direct person-to-person purchases, or peer-to-peer marketplaces.
To deposit or withdraw money in a cryptocurrency exchange, you need to provide your personal identification information, including name, e-mail address, and proof of ID.
To make buying or withdrawing Bitcoin more convenient, many cryptocurrency wallets let you link your bank account with their app. By doing so, you are connecting your real-world identity with your Bitcoin transactions.
Additionally, you can reveal your real-world identity by buying stuff online and providing your physical delivery address or a phone number.
It might get even worse if you purchase illicit goods and services in the hidden corners of the dark web. A leak from Edward Snowden proved that the NSA had been tracking Bitcoin transactions from Silk Road quite extensively. Even though Silk Road was shut down in 2013, many other dark marketplaces are still in operation and actively monitored by authorities.
When Silk Road was still in operation, a group of Forbes journalists went out and bought drugs online. Everyone associated with the experiment has been identified—proving that Bitcoin is not an anonymous digital currency.
Bitcoin transparency problems
The increasing problem with Bitcoin is that the previous owner's activities can contaminate them.
Let's say someone uses Bitcoin to commit a crime. To get rid of these coins, one sells these at the person-to-person or peer-to-peer marketplace, at a favorable rate.
Eventually, those coins end up in your hands. You received them legitimately and want to send them to a cryptocurrency exchange. To your shock, the exchange refuses your funds, telling you that your coins have been blacklisted. In the worst-case scenario, you might even have to turn your Bitcoins over to the authorities.
Because Bitcoin can be contaminated and possibly blacklisted, they may be worth less than the "clean" ones. Even though there have been very few such cases publicly disclosed, the growing blockchain analytics industry may soon make things much worse.
There is a whole bunch of blockchain analytics companies, such as Chainalysis, Elliptic, or CipherTrace. They sell their crypto intelligence services to governments and businesses for blockchain surveillance and detection of criminal activity.
Coinbase, one of the world's largest cryptocurrency exchange, recently acquired the controversial blockchain analytics company Neutrino. Shockingly, Neutrino's core executives have previously founded Hacking Team, an Italian firm that sold spyware to governments linked to human rights abuses.
With the growing number of regulations and tools that help authorities to control the observance of these regulations, it is imperative to keep your Bitcoin private.
Making Bitcoin anonymous
Luckily, you can make Bitcoin anonymous. There are several privacy-enhancing tools available, however, to make your Bitcoin transactions untraceable, always follow these few steps:
- Buy Bitcoin anonymously. In today's controlled world, to buy Bitcoin anonymously without proof of ID, you have only a few options available: Bitcoin ATMs, Person-to-person purchase, or Peer-to-peer marketplace. If you don't want to link your real-world identity with coins you own, always buy crypto anonymously.
- Create and use multiple anonymous bitcoin wallets. You can have as many wallets as you like. Ideally, you should use a different wallet for a different purpose. You should have at least an offline wallet for the long term and high security, to keep most of the coins you don't use very often. Then, you can have the main "clean" wallet for day-to-day transactions. Finally, you can have a special, anonymous wallet for deals you wan to keep private. Even though you can achieve privacy by using different addresses, the main reason for using individual wallets is not to mix up your funds.
- Use a new receiving address for each Bitcoin transaction. It is not advised to re-use addresses since it allows other users to see how much funds you have and reduces plausible deniability. By giving out different addresses for different payments, other users paying you won't know for sure how much money you have. Additionally, they won't know if other users have already paid you.
- Use a VPN service or route your traffic through the Tor network. To protect your IP address when making Bitcoin transactions, conceal it by using a VPN service. If you are concerned about your privacy, you can use a dedicated privacy operating system Tails, that routes your entire traffic through the Tor network. Additionally, Tails has a built-in Bitcoin wallet app Electrum you can use right off the bat.
- Mix or anonymize your Bitcoins. Bitcoin mixer shuffles the coins to make them harder to track. Your coins are mixed with other Bitcoins from the mixer's pool. On the other hand, Bitcoin anonymizer converts Bitcoin to a dedicated privacy cryptocurrency such as Monero or Zcash, making them utterly untraceable.
Unless you know what you are doing, it's best to assume that with Bitcoin, you have little to no privacy. In such a case, to stay completely anonymous, keep away from Bitcoin entirely, and use a dedicated privacy coins, such as Monero or Zcash.