Now that we know how Bitcoin works, we understand that every bitcoin transaction is broadcasted publicly for the world to see and saved in an irreversible public blockchain. This makes Bitcoin quite possibly the least private way to manage your money!
Bitcoin is said to be “pseudonymous” because technically your bitcoin addresses on the blockchain act as your username in place of your true identity. Personally identifiable information like your name, phone number, etc. are not visible on the blockchain – but what happens when you identify yourself?
For example, let’s say you buy Bitcoin on Coinbase and then withdraw it to your personal wallet. Since Coinbase knows who you are, and now they know the address of your wallet outside the exchange, they can simply watch that address on the blockchain and associate your identity with every transaction involving that address.
In the early days of crypto, the only time you identified yourself was if you wanted to connect your bank account to an exchange. If you already had crypto, you could signup with any random email address, deposit your crypto and trade fairly anonymously. But in 2018 this all changed when the US’s Financial Crimes Enforcement Network (FinCEN) cracked down on the crypto industry and began enforcing Anti Money Laundering (AML) and Know Your Customer (KYC) requirements on the exchanges.
Not only are exchanges required to collect loads of personal information about you, but they’re also obligated to monitor your transactions for “suspicious activity”. If they discover transactions related to gambling, drugs, money laundering, etc. they may be required to freeze your assets and report you to the government.
Mapping identities and suspicious activity on the blockchain is incredibly complicated and requires sophisticated machine learning technology. Blockchain forensic companies like Chainalysis have sprung up to assist governments and exchanges in their AML/KYC compliance efforts.
These companies monitor known addresses of exchanges, gambling websites, darknet markets and suspicious actors to flag any transactions they come in contact with. Bitcoins involved in these transactions are said to be “tainted”.
Protecting Your Privacy
Most Bitcoin users believe the monitoring and surveilling of every financial transaction in the world to uncover a sliver of illegal activity is a gross invasion of privacy. Here’s a few common ways to protect your privacy while using Bitcoin:
- Run a node – By connecting your wallet to your own node, you are not relying on a 3rd party for downloading your transaction history or broadcasting your transactions.
- Use Tor or a VPN – If you’re not running your own node, at least use a VPN so the node you’re routing through can’t identify you via your IP address.
- P2P exchange – Buying/selling bitcoin directly with another person can be done more privately than via a public exchange.
- Maintain separate wallets – Keep bitcoins linked to your identity in a separate wallet from bitcoins acquired anonymously.
- Coinjoin – Coinjoining is a technology for obfuscating the transaction history of your bitcoin and “removing taint”. Common wallets for implementing a coinjoin are Wasabi and Samourai.
- Lightning – The Lightning Network is a second layer scaling solution for Bitcoin which allows you to transact “off-chain” and is inherently more private.
- Privacy Coins – Some altcoins like Monero and Zcash attempt to obfuscate transactions on their network at the base layer. Whether blockchain forensic companies can track users of these networks is debatable.
Guaranteeing privacy while using Bitcoin is complicated but not impossible. Whether you have something to hide or not, you have a right to privacy and should take necessary steps to protect your privacy whenever possible.