How Private is Bitcoin?
Is Bitcoin really private?
Many newcomers to Bitcoin assume it’s fully private and often hear media claims that it’s “mostly used by criminals.” However, neither of these assumptions is true. Let’s see Bitcoin’s level of privacy, the importance of privacy for Bitcoin users, and how various groups work to either protect or erode it.
Are Bitcoin Transactions anonymous?
Bitcoin is based on an open, publicly auditable ledger. Every transaction is recorded, showing the transfer of Bitcoin between addresses. However, these addresses don’t contain personal information like names, phone numbers, or physical addresses. This makes Bitcoin pseudonymous, not anonymous.
Pseudonymity provides privacy while allowing Bitcoin’s full supply to be auditable. If Bitcoin were fully anonymous, ensuring no extra coins were created would be difficult.
Chain Analysis
Despite Bitcoin’s pseudonymity, governments and chain analysis companies invest resources into reducing Bitcoin users’ privacy. While some of this research aims to track criminals, it is also used to monitor dissidents and individuals seen as state opposition in certain countries.
KYC and AML Laws
In many places, regulations require Bitcoin exchanges, custodians, and brokerages to verify their customers’ identities, known as Know Your Customer (KYC) and Anti-Money Laundering (AML) laws. These businesses must store personal data and share it with authorities if requested.
When a customer buys Bitcoin and withdraws it from an exchange, the platform records the associated Bitcoin address. Some exchanges even share this information with chain analysis firms, who track the customer’s funds before and after the transaction, compromising Bitcoin’s pseudonymity.
What is Blockchain Analysis?
Blockchain analysis companies use various techniques, like the common input ownership heuristic and the round amounts heuristic, to trace Bitcoin ownership across transactions.
For example, if Alice sends 1 BTC to Bob using two inputs (0.5 BTC and 0.7 BTC), a blockchain analyst might conclude that the output with a round amount (1 BTC) is likely for Bob, and the remaining amount is change returned to Alice. By combining this data with known addresses (from KYC-compliant exchanges), analysts can infer ownership and follow the Bitcoin trail.
Despite the fact that the 0.199 UTXO was newly created with the transaction it’s obvious that Alice is the Owner of it.
How to increase Bitcoin Privacy
KYC and AML laws, along with chain analysis, reduce Bitcoin’s privacy, which can lead to compromised safety for activists, dissidents, and people opposing oppressive regimes.
Developers are working on tools to make chain analysis less effective and preserve Bitcoin’s pseudonymity. Off-chain solutions, like the Lightning Network and Liquid Network, allow users to make Bitcoin transactions without recording them on the public blockchain, enhancing privacy.
Final Thoughts
- Public but Pseudonymous: Bitcoin’s blockchain is open and pseudonymous
- Privacy Challenges: Governments and chain analysis companies use blockchain data and KYC/AML information to track transactions.
- Privacy Solutions: Developers are creating tools to protect Bitcoin users’ privacy and allow them to transact securely.