It’s a well-known fact that Bitcoin is an untraceable payment method. And that’s part of the reason why it’s so appealing to most people. But the downside of this is that it attracts criminals who use it as a way to process payments for illicit activities.
However, what most people don’t realize is that while Bitcoin payments are untraceable, the users making the payments can be tracked. Bitcoin privacy concerns have given many users sleepless nights and we’re going to explore why.
How Does Blockchain Work?
First of all, it’s important to note that Bitcoin is pseudonymous instead of being anonymous. It’s also based on peer-to-peer, decentralized technology, with no third-party mediators. That means there are no banks, processors or card issuers to deal with. So, how are Bitcoin transactions verified then? After all, it’s important to verify transactions in order to avoid double-spending.
It seems that blockchain comes handy in this regard. Blockchain is a public ledger that’s distributed among users and it’s the holding place for all cryptocurrency transactions. The difference between the blockchain ledger and conventional payment systems is that the former is maintained by thousands of different computers. And each provides an exact copy of every transaction. This is in stark contrast with the conventional credit card situation where a single third-party maintains conventional payment systems. But, this hasn’t stopped users from having Bitcoin privacy concerns.
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Anonymity vs. Pseudonymity
As mentioned, the blockchain record is designed to maintain a public record of all Bitcoin and other cryptocurrency transactions permanently. So it’s definitely not anonymous. Although they’re available as a matter of public record, Bitcoin transactions are protected by public key cryptography. This is a type of encryption technology that hides the identity of the sender and receiver involved in the transaction. That’s why Bitcoin and cryptocurrencies in general are considered pseudonymous.
With every Bitcoin transaction, the individual users are assigned two unique digital keys. The first one is a public key or a public address that comes from the public key. It’s published on the public blockchain record. The second one is a private key which is known as a signature and is only shown to the user.
Since it’s a user’s “signature”, the private key can be used to verify the identity of the user that made the transaction. This is one of the factors that give people Bitcoin privacy concerns. However, if you look in the blockchain, the only thing you’ll see is evidence of the transaction. You will also see the public keys involved in making it happen. The 34 random alphanumeric characters involved show the amount involved and the time during which the transaction took place.
Can BTC Be Traced Backed to Individuals?
One of the major Bitcoin privacy concerns stem from the fact that it’s traceable. Even though transactions must go through strict encryption technology. It’s entirely possible to match an encrypted transaction to a specific individual. How does it happen?
For starters, individuals are obligated to disclose their personal information whenever they want to exchange currency for Bitcoin. This is regardless of the platform they’re using. In order to create an exchange account on Kraken, Binance or Bifinex for example, you must prove that you’re a real human being. This requires you to provide credentials like your phone number, first and last name and also your IP address. There are also a few centralized exchanges that go the extra mile. They will actually offer to manage a user’s private keys, while others will manage user wallets on behalf of the user.
In case you’re wondering, an online wallet is a type of software that you can use to keep all your private and public key pairs. However, storing keys in a private wallet and on a centralized exchange is like putting a target on your back nowadays, especially if you’re someone that has accumulated a lot of crypto wealth. Once a hacker accesses just one of your private keys, he/she will gain access to your account and can transfer all of your Bitcoins to his/her own account.
Another method that you can use to identify a Bitcoin user is to track their activity in the blockchain. It’s incredibly easy to track user activity in the blockchain nowadays, thanks to the presence of tools such as Chainalyis and Elliptic, which are dedicated to blockchain forensics. These companies are mostly used by government agencies and individuals as risk assessment tool that provides up to date analytics on the Bitcoin blockchain. Some of the high-profile clients that use Chainalyis include the IRS.
Not only that, but several studies suggest that you can also determine a crypto user’s identity based on their blockchain transactions using methods like network analysis. One study, in particular, stands out and it was actually a collaboration between researchers in George Mason University and the University of California back in 2013. The researchers were able to determine who certain Bitcoin addresses belonged to by using a method known as clustering analysis. The research team focused on a few private transactions at a time, and that allowed them to recognize which institutions were involved in the transactions and determine where the funds are going. It’s all very fascinating really.
Furthermore, NEC Laboratories Europe partnered with ETH Zurich on another study which involved analyzing a small sample of Bitcoin transactions. What these researchers found was that you could uncover the addresses of up to 40% of profile users using behavior-based clustering techniques.
How to Increase Privacy
While it might seem like using Bitcoin is not much more private as normal payment methods, not all is lost. There are methods that you can apply to beef up the security on your Bitcoin wallet and achieve better privacy. Something which is not possible when using Credit Card or Paypal. One way would be to create a new Bitcoin address for every individual transaction that you make in the blockchain. You’ll receive a unique public key with each transaction. This way, you will minimize the chances of anyone tracing the transaction back to your address.
This privacy method is mentioned in the original Bitcoin white paper. The white paper was released by Satoshi Nakamoto when the crypto was founded. As the founder of Bitcoin, Nakamoto remains pseudonymous to this day and he recommended that users create a new key pair to go with every individual transaction they make to avoid being identified and targeted.
Another second method you could use to maintain privacy on Bitcoin allows you to reduce the risk of being traced by other exchanges. How does it work? You’d have to access the exchange through an anonymous VPN like IPVanish. That way, you can create an account without divulging your personal IP or credentials.
The third method would be to only store your Bitcoins in offline desktop wallets. This is instead of storing them in third-party wallets that are based online.This method will significantly diminish your risk of being hacked within the exchange. The last method involves joining Bitcoin mixing algorithm like CoinJoin. This algorithm works by combining different user accounts and mixing up their transactions so that no-one from the outside can tell where the Bitcoins are coming from.
Since this method makes it possible to publish multiple transactions at a time, it makes it extremely difficult for third-party observers to identify individual users. However, determined hackers have been known to take advantage of certain weaknesses within the CoinJoin algorithm. This is in order to link transactions back to individual users.
While it is hard but not impossible to remain completely anonymous on Bitcoin, you can achieve pseudonymity. Not only that, but Bitcoin is still safer than traditional fiat currency.