Is Bitcoin anonymous?

What does anonymity mean in the context of bitcoin?

You might be surprised to find out that under some circumstances, using Bitcoin as a means of payment is actually a lot fewer anonymous than using good old cash. Hence, in this case, the transparency and accessibility of all transactions on a public ledger is a double-edged sword. On the one hand, it is an important feature for creating consensus among all network participants and to validate transactions, which creates trust. On the other hand, all the publicly broadcasted information can be aggregated and potentially used to attempt to uncover the identity of users behind wallet addresses. So if you’re actively using and spending your digital currencies, this is an important aspect that you need to be aware of.

What exactly is Bitcoin if it’s not anonymous?

Well, you may know that your Bitcoin wallet address is a so-called public key. In fact, it’s the hash of a public key to be precise. Sounds difficult? It just means that you don’t need to use your real name in order to interact with other users in the Bitcoin system when sending or receiving your coins. What is published instead are the public key hashes that act as a sort of pseudo identities? That’s what computer scientists call pseudonymity. So, you now may wonder, if you’re using a pseudonym, and you can even create as many of these as you like, doesn’t that make you anonymous? Well, the short answer is: not exactly.

Conceptionally, anonymity is pseudonymity combined with unlinkability. That means I am only truly anonymous if my interactions with the network that I do under my pseudonym cannot be tied to each other by someone else. That is not the case in Bitcoin. So, to answer the first question, Bitcoin is pseudonymous and not anonymous.

Why exactly is it possible to de-anonymize Bitcoin users?

Let’s think about how Bitcoin transactions roughly work: all transactions are processed using public-key cryptography. This just means that digital signatures are used as a way of proving ownership of your coins. The so-called chain of digital signatures means that each transaction is linked to the output of the previous one to verify that the user has enough funds to perform the new transaction. What happens every time a new transaction is made, is that it is cryptographically signed by the user with his private key. Then, the transaction containing the input and output addresses and corresponding amounts is broadcasted to the network where other nodes can validate it. Therefore, if we think about it, the Bitcoin system essentially consists of two layers. One that we call the application layer, which includes the information that is stored on the blockchain, and the one that we call the networking layer, which is the peer to peer network in which messages are sent around. Both of these layers can be used to de-anonymize users. Now that you understand that Bitcoin is pseudonymous and both the application layer, as well as the networking layer hold information that can be used to uncover the real-world identity behind users.

Okay now let’s have a look at some techniques that make this possible.

At the application layer, someone might use a technique called transaction graph analysis to aggregate information and investigate how the money is moved around in the Bitcoin system among different addresses. So, what’s interesting for example is that transactions with multiple input addresses reveal that they are owned by the same user. It means that by using wallet software to pay for a cup of coffee, for instance, coins from several different wallet addresses are sourced if one of the addresses has insufficient funds, for example. This is what we call joint spending. In other words, joint spending is evidence of joint control, if you like, because it can be inferred that all the pooled addresses must belong to the same user. So, by transitively aggregating the addresses, clusters of linked addresses can be collected. Since all of the information is stored in the blockchain forever, it is possible to gain more information on the user’s activity by looking at these clusters over time.

Likewise, spending patterns can then be revealing the user’s identity. Another way to infer the real-world identity from an individuals’ address clusters is by analyzing the interactions with clusters from already known service providers. So if you think of the coffee example again, your interaction with the coffee shop reveals an address that corresponds to you. This, in turn, can be used by the other party to then tag your cluster. Now, another important fact in this context is the high centralization in well-known large service providers, such as wallet providers exchanges, for instance. Therefore, there is a high probability for individual users to interact regularly with one of those well-known clusters. Ultimately, this makes it possible to identify a transaction that ties the individual’s cluster with the well-known one of the service providers. Provided that the service provider e.g. an exchange possesses some revealing information on his or her customers, an authority, for instance, can demand access to that information e.g. by subpoena, and use it to uncover the real-world identity of the user behind the individual address cluster.

The previous two examples mainly focused on techniques that can be applied to the Bitcoin application layer data for de-anonymization. But, as mentioned before, there is also the networking layer in the Bitcoin system. A potential method that can be applied to this layer to uncover the identity behind an address is entirely unrelated to clustering and using transaction graphs. The idea here is to focus on the broadcasting process of the peer to peer network. The point is that a node is going to connect to many others whenever it wants to broadcast a transaction that is created. Therefore, several nodes who heard about the transaction could cooperate and try to figure out where the new transaction came from.

So if they figure out which transaction is new and which node broadcasted the transaction, then this probably represents a direct link between a transaction and the IP address of the user who created the transaction. Given that an IP address is quite close toa real-world identity, this is a severe problem if you’re concerned about privacy. Since this is mainly a problem of communication anonymity, though, and the field has received significant attention from the research community, tools like for example Tor have been developed to communicate anonymously.

CONCLUSION

Well, first of all, you are now aware that there are a couple of tricks and methods that can be used to link different addresses or transactions to Bitcoin users because the Bitcoin system is pseudonymous, rather than truly anonymous. What’s more, it does not stop here, but even uncovering real-world identities or IP addresses of Bitcoin users is a possibility. Bear in mind that all transactions are stored in the Blockchain forever and if your address is ever linked to your identity, every transaction will be linked to you. So make sure to inform yourself about the recommended best practices when transacting in Bitcoin and other cryptocurrencies to keep your privacy as safe as possible.

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