- How Do Bitcoin Transactions Work?
- How Is Bitcoin Anonymous?
- Anonymizing Bitcoin Using the Coin Clustering Technique
- So, How Is This Anonymity Defeated?
- How Can You Increase Privacy and Anonymity When Making Bitcoin Transactions?
- Final Thoughts
Bitcoin has been in existence since 2009, and it is often described as a way to transact anonymously online. But, is it true that Bitcoin is anonymous? Can you completely hide your identity when using this digital currency? That is what we are going to discuss in this article to help you make sound decisions when using Bitcoin to transact.
Is Bitcoin anonymous? No, Bitcoin is not completely anonymous, as some people tend to believe. In reality, this digital currency is pseudonymous since each user has a public address that can be traced back to a specific IP address or exchange account.
In fact, a significant number of individuals have had their identities revealed by investigating public blockchain transactions. Several companies that investigate bitcoin transactions to reveal identities have already been set up in recent years.
In simple terms, transferring and receiving bitcoins is much like communicating using a pseudonym. This means that if a pseudonym is linked to your identity, everything you ever said or did under that specific pseudonym will be linked to you.
In Bitcoin, your pseudonym is the specific wallet address to which you receive Bitcoin. Every Bitcoin transaction involving that address is stored forever in the blockchain. If the address is ever linked to your actual identity, every transaction under that address is automatically linked to you.
How Do Bitcoin Transactions Work?
To help you understand the concept of Bitcoin anonymity better, it is critical first to understand how Bitcoin works on an elementary level.
Typically, the Bitcoin protocol consists of a series of transactions. Each transaction is basically a package of different kinds of data. The data primarily consists of transaction inputs and outputs.
In this case, input refers to the addresses used to send bitcoin from while output refers to addresses used to send bitcoin to.
Technically, each Bitcoin transaction can transfer bitcoins from one or several inputs to one or several outputs. It is also possible for a transaction to simply have one input and one output, although it is quite rare since it will require the amount of bitcoin sent (output) to be precisely equal to the amount of bitcoin received earlier (input).
For example, if Bob has a bitcoin address with 1BTC and he wants to send Josh 1BTC, then in such a case, there will be no change address generated. Bob had one bitcoin, wanted to send one bitcoin, and that is exactly what happened. End of story.
In normal circumstances, a single bitcoin transaction will consist of multiple inputs and outputs. This is possible because bitcoin technology relies on a simple concept known as “change addresses.” In simple terms, a change address allows a user to create a bitcoin transaction that returns the excess amount of BTC from one or several inputs back to the sender.
For instance, if you control three different inputs of 1BTC each and you need to send 2.5BTC to an online retail store, the system will merge all the three inputs into a single bitcoin transaction. Once it has sent 2.5BTC to the online retail store, it will generate a new 0.5 BTC output attribute and send it back to the newly generated (change) address that is controlled by the sender.
So, how does this process affect bitcoin anonymity? Before I answer this question, let us see why this digital currency is perceived to be anonymous.
How Is Bitcoin Anonymous?
A better question would be: to what extent is Bitcoin anonymous? Well, there are three primary reasons why bitcoin is sometimes considered to be anonymous:
First, unlike other payment systems such as bank accounts, all bitcoin addresses are not tied to the actual identity of users on a bitcoin protocol level. Technically, anyone can create a new bitcoin address plus its corresponding private key without submitting his/her personal information to anyone.
Second, bitcoin transactions are not tied to the actual identity of users either. Anyone can transfer bitcoins from any address to another address without revealing their personal information. Just like physical cash, not even the receiver of bitcoins needs to know the identity of the sender.
Lastly, all bitcoin transaction data is transmitted and forwarded by nodes to another random set of nodes on the network. Although these nodes connect to each other using their IP addresses, it is not easy for a node to establish whether the bitcoin transaction data it receives was actually created by the node it is connected to or if that node was only used to forward the data.
Anonymizing Bitcoin Using the Coin Clustering Technique
Over the past few years, the idea of clustering multiple bitcoin addresses together to enhance anonymity has been on the rise. This is commonly referred to as CoinJoin.
CoinJoin is a unique type of bitcoin transaction in which multiple entities or people come together to create a single transaction featuring all of their inputs. This type of transaction makes it more difficult for outside parties to establish which sender paid which recipient/ recipients.
A user who wants to implement CoinJoin in his/her transaction must seek out another user who wants to do the same. After agreeing, both parties initiate a joint transaction. CoinJoin will combine the inputs and outputs of such a transaction and record them as a single transaction to the public blockchain ledger. This way, it becomes difficult for an outsider to match the inputs to their respective outputs.
I will use the following example to illustrate this aspect:
Let us assume that the following bitcoin transactions were conducted at the same time: Person A buys a commodity from person B, person C buys a commodity from person D, and person E buys a commodity from person F.
Without the CoinJoin technology, the blockchain ledger would record this scenario as three different transactions for every input-output match (A→B, C→D, E→F). However, with CoinJoin, the inputs and outputs of such a transaction are recorded to the public blockchain as a single transaction, making it difficult to match the inputs to their respective outputs.
So, How Is This Anonymity Defeated?
So, how is this anonymity defeated? Since your pseudonym (bitcoin address) is recorded, there is a possibility of tracing your identity using the pseudonym. This can happen in multiple ways:
One of the critical components of Bitcoin that make it transparent and highly traceable is the fact that every transaction made is usually recorded and stored in a huge public ledger known as the blockchain. The ledger is hosted and shared by anybody running a conventional bitcoin node.
The primary purpose of the blockchain ledger is to help ensure that coins are not spent twice, and only the individual with the private key can access them. But, this move violates privacy and de-anonymizes bitcoin.
Technically, anyone who knows your bitcoin wallet address can enter into the blockchain public ledger official explorer and see your wallet balance and a history of all the transactions you have ever made.
Any transaction with someone who knows your identity can also be catastrophic if you want to remain anonymous. Such a transaction can leak crucial information that can be used to reveal your identity.
For instance, if you transfer bitcoins to an exchange, online retailer, or any other merchant that captures customer identity information, you allow them to link that information to your bitcoin pseudonym, which can reveal the other transactions that you are a party to.
Technically, all transactions over the extensive bitcoin network are transparent and traceable by almost anyone.
Bitcoin traceability provides the ultimate paper trail for tax authorities, law enforcement agencies, and compliance professionals. Several governments all over the world have been looking into Bitcoin regulation for a while now, with identification being one of the focal points in regulation. This is something that a lot of people don’t like.
However, this is no surprise because hiding your identity 100% in the digital world is a little bit tricky. In one way or the other, you will always leave behind your digital footprints. Therefore, if you think that you can do anything with bitcoin transactions, you need to think again.
How can bitcoin be completely anonymous when the technology that traces darknet activity continues to get better? Governments and hackers are working hard to find ways of tracing bitcoin transactions to specific individuals. Whether or not they will succeed remains to be seen, but the truth is that they have been making serious leeway.
How Can You Increase Privacy and Anonymity When Making Bitcoin Transactions?
The truth is that some effort is required to protect your privacy with bitcoin and increase levels of anonymity. Increasing the level of your privacy and anonymity while transacting online will significantly lower any risk of getting scammed or hacked.
While the bitcoin system is built on solid and unyielding cryptography to stop different kinds of fraud, the human component in bitcoin transactions is still seen as the weakest link.
In this section, we shall discuss some of the things you can do to ensure privacy and anonymity when making bitcoin transactions.
Always use a new address for each transaction: Today, almost every bitcoin anonymous wallet is a Hierarchical Deterministic wallet, commonly referred to as an HD wallet. With an HD bitcoin wallet, you can derive keys from a single starting point referred to as a seed. Every seed allows you to easily backup and restores your wallet without needing any other information.
Since seeds are serialized into human-readable texts, you can use the 12-word or 18-word seed phrase included in your HD wallet to generate private and public keys. This means that you can generate an infinite number of addresses and every time you receive bitcoins from anywhere, you can use a new address.
While this may seem a little bit confusing to new users, it is a good practice to ensure bitcoin anonymity. Generating a new address for every transaction you make makes it hard to link two or more bitcoin transactions to you.
Bitcoin mixing: As mentioned earlier, all bitcoin transactions are recorded on a public ledger. This means that anyone who can trace a public address can know the origin of a transaction. In this case, there is no protocol level procedure to anonymize bitcoins.
Bitcoin mixing is a simple process that tries to break the traceability or linkability. Bitcoin mixers such as smartmixer literally mix up your transaction details with lots of other transaction details from other users.
Put in another way, mixers take up a bitcoin address and return a completely new address of the same value minus the processing fee. This ensures that the transaction cannot be linked to you.
Use the onion router (TOR) to stay anonymous: You can also use a TOR browser to connect to the bitcoin network anonymously. TOR is basically a volunteer community that believes in surveillance-free and anonymous internet usage.
If you are looking for something to aid bitcoin anonymous buy activities, then TOR could be a possible solution. With TOR, it is almost impossible to establish where the transaction originates because all your traffic is routed to a random computer on the network before it is sent to its destination.
However, if you are using a Know Your Customer (KYC) enabled bitcoin site, then using TOR may not be useful. It is also good to mention that TOR does not guarantee 100% privacy, and it is always a good practice to combine it with a VPN.
Use a logless VPN: A logless VPN (virtual private network) does not store a record of your online activities on their servers. Instead, it encrypts all your traffic and routes it through different servers of your choice located in different regions before arriving at the destination.
Some logless virtual private networks feature a shared IP address for several users, making it even more difficult to trace one’s identity.
Contrary to popular belief among the general public, bitcoin is not anonymous. In fact, it is possible to track bitcoin transactions conducted online and link them to specific people.
However, this doesn’t mean that you cannot make bitcoin transactions anonymously. There are lots of things you can do to ensure that you use this digital currency anonymously. The bottom line is that it is up to you to decide the level of anonymity you require online. Technically, the more anonymous you want to be, the more effort you need to put in to succeed.
I hope you enjoyed reading this article. Let me know your thoughts in the comments section.