Many people are under the misconception that Bitcoin is completely anonymous since sending and receiving it does not include transmitting any personally identifying information. However, the reality is that Bitcoin is not truly anonymous and this is stated clearly in Bitcoin.org’s Things You Need to Know section. While some measure of anonymity can be achieved, it is not easy to achieve it and users of Bitcoin will not be truly anonymous.
Yes, it is true that an individual can use Bitcoin without providing their name; however, all their transactions can be connected to the address to which they receive their Bitcoins. This means that those transactions can all be tied to them if that address is ever connected with their personal identity. It is therefore a good idea for Bitcoin owners to use multiple addresses, a new one for each transaction. While this method can certainly help with anonymity, it is not perfect. To understand why Bitcoin is not completely anonymous, it is important to look at how it works.
How Bitcoin Transactions Work
A Bitcoin transaction consists of inputs and outputs. Inputs are addresses from which Bitcoin is sent. Each address has a private key and Bitcoin can only be spent using the private key from those addresses. Outputs are the address to which Bitcoin is sent. During a transaction, Bitcoin is transferred from one more inputs to one or more outputs. While it is possible for transactions to have a single output and a single input, this is rare.
In most cases, each transaction will be comprised of multiple smaller inputs. Similarly, it will also contain multiple outputs. If someone controls two outputs of a single Bitcoin each and they need to buy something for 1.5 Bitcoin, the software will merge the outputs to create one transaction. Multiple outputs are necessary because of change addresses that return the extra Bitcoin. With the 1.5 Bitcoin example above, 2 Bitcoin will be attributed to the seller with 0.5 Bitcoin being attributed back to the buyer’s change address.
How Bitcoin Anonymity Can be Compromised
• The peer-to-peer network over which Bitcoin transactions are transmitted is not 100 percent secure. Attackers may be able to determine the origin of a transaction simply by connecting multiple nodes. These nodes may be able to provide enough information to determine a transaction’s source.
• Another way that anonymity can be compromised is if the user’s personal identity is used along with the Bitcoin addresses. For example, addresses used to deposit money or with draw it from a wallet service. If any of the input addresses in a transaction are ever connected to the buyer’s identity, none of the other addresses will be anonymous.
• A third way in which Bitcoin anonymity can be defeated has to do with the fact that Bitcoin transactions are open to all and can be traced. This allows for a group of different Bitcoin addresses to be connected to one user. If any of these addresses are connected to a personal identity then all the other addresses in the group can be as well.
Ways to Improve Bitcoin Anonymity
• Using Multiple Wallets
The use of multiple wallets is similar to having multiple identities. A Bitcoin owner can use software that will allows them to manage multiple wallets from one interface.
• Using a Mixing Service
A mixing service stores its users’ Bitcoins together and then sends them out randomly with the goal of making it impossible to determine which outputs and inputs are connected. This can be effective but requires that users trust the anonymous mixing service to return their Bitcoins and to not record the transactions. There is also nothing to stop a mixing service from simply taking all the Bitcoin and disappearing.
• Online Wallets
It is possible to hide the original owner of Bitcoins with these services as they store all the users’ Bitcoins together. The benefit is that users get different Bitcoins when withdrawing. This can work for users whose Bitcoin does not make up a large portion of the service’s balance. In this case, it is also important that the service be active.
• Avoid Publishing Addresses
Bitcoin owners should refrain from publishing addresses. Unless an individual is soliciting donations and wants to be completely open and transparent, publishing a Bitcoin address along with their personal identity means that any donations they receive can be traced back to them. Also, publishing information about purchased items is another way for Bitcoin addresses to be traced back to the owner.
Expected Improvements in the Future
Among the ways that Bitcoin privacy is expected in improve are upgrades to the API to keep multiple addresses from being tied to each other during a payment. There may also be improvements made to graphical user interfaces to provide easier-to-use payment request functionality while also discouraging the reuse of addresses. Ways to join the transactions of random users are also being researched in order to enhance user privacy.