It’s been almost 12 years since the launch of Bitcoin and it’s come a long way since then. But many myths about the technology still persist, with one of the most widely believed, yet deeply mistaken, being the idea that Bitcoin is “only-used-for-buying-things-that-are-illegal.” Because it’s anonymous.
This myth persists despite the fact that it’s completely contradicted by recent developments, such as large publicly traded companies converting some of their cash reserves into Bitcoin. Clearly Bitcoin’s use case goes far beyond selling drugs on the internet.
And the simple fact is, Bitcoin isn’t actually anonymous at all. The movement of individual coins (or fractions of a coin more likely) can be precisely traced.
Some other crypto currencies created in the wake of Bitcoin were specifically designed to be anonymous, with transactions details on these networks being completely hidden. Monero is probably the most well known privacy focused coin and it was designed in stark contrast to Bitcoin’s lack of anonymity.
The problem with total anonymity (and likely the reason why Satoshi avoided making Bitcoin anonymous) is that it makes it more difficult to verify the supply, which is a crucial part of Bitcoin’s core value proposition.
Bitcoin allows anyone with basic computer skills, a working computer and access to the internet, to easily verify its supply. You don’t need programming skills to do this. This is however only possible because all addresses, balances and other transactions details are completely transparent.
Bitcoin is pseudonymous. Not anonymous. Every single transaction on the Bitcoin blockchain is visible. You can see the address it was paid from, the address it was paid to, the amount that was paid and whether there was any change left and to which address the change was sent.
In this way individual coins (and fractions thereof) can be traced throughout their entire existence. From the moment they were mined, whether yesterday or 10 years ago, until today, regardless of how many times it was transferred from one address to another. And regardless of how many times it was broken down into smaller fractions or combined into larger amounts.
Now, initially there is no real world identity linked to any particular bitcoin when it’s first mined. This is why it’s pseudonymous and not anonymous. But inadvertently linking a real world identity to a Bitcoin address can happen very easily. And it happens all the time. Most often through exchanges where people buy and sell Bitcoin.
The vast majority of exchanges have to keep customer records, seeing as they fall under the legacy financial system where, in most jurisdictions, money services are highly regulated. Thus the moment you send or receive Bitcoin from an exchange to any other address on the Bitcoin network, your real world identity becomes linked to that particular Bitcoin address, in much the same way that your identity is linked to your bank account number. And because all transactions on the Bitcoin blockchain can be openly viewed, regardless of where you move the coins, you inevitably leave a trail that can always be traced back to you.
In a perfectly circular Bitcoin economy (sometimes referred to as hyper-bitcoinization) there would be no real world identities unintentionally linked to Bitcoin addresses. This is the hypothetical future scenario where the entire economy is priced in terms of Bitcoin and people do not sell Bitcoin for other currencies, as is done today, but instead pay for goods and services directly with Bitcoin.
Today, however, Bitcoin is almost always bought and sold, several times over, on various exchanges, in various jurisdictions. And so very few coins exist today that have never interacted with the legacy financial system of KYC and AML regulations. This makes most coins highly traceable to real world identities.
In fact, in this video Kathryn Haun, a former U.S. Attorney who was involved with the Silk Road case (arguably the most infamous financial crimes investigation linked to Bitcoin) explains that when it came to investigating financial crimes prosecutors and investigators preferred cases where funds were moved using Bitcoin, rather than cash or even regular bank accounts. Precisely because of Bitcoin’s high traceability. She calls Bitcoin a “digital trail of breadcrumbs.”
And there’s an entire industry of companies that have built business models around the traceability of Bitcoin. These companies provide Bitcoin network intelligence to government agencies and private clients alike.
That being said, Bitcoin can provide a high level of anonymity. If you employ very specific techniques.
These techniques include mixing pools and coin joins, but it’s mostly only highly experienced users that do this. And there are several other considerations. They must be specifically implemented, at an extra cost. They do not yet work well for large amounts. Realistically only smaller amounts can anonymized in this way. These (or similar) techniques are also not (yet) built into the network by default. Furthermore, they do not make transactions less transparent. Instead they employ cryptographic techniques to remove previous links between real world identities and Bitcoin addresses, but the transaction details remain as transparent as they’ve always been.
Why was Bitcoin designed this way?
Satoshi Nakamoto likely saw the transparency as a good trade-off to ensure Bitcoin’s core value proposition.
Because contrary to popular belief Bitcoin was not created to evade authorities through anonymity. First and foremost, Bitcoin was created to be a trustless store of value and a means of transferring that value.
As Satoshi himself wrote:
“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency but the history of fiat currencies is full of breaches of that trust.”
What Satoshi was referring to was the practice of monetary debasement, whereby the value of a currency is decreased either through supply inflation or by diminishing the inherent value of each unit.
Since the Great Financial Crisis of 2008 / 2009, and even more so during the Covid-19 Pandemic in 2020, governments around the world (and western governments in the US and Europe in particular) created vast amounts of new currency units, inflating their monetary base beyond levels anyone ever imagined possible, despite economies shrinking.
And small localized examples of where this may be heading already exist. Zimbabwe, Venezuela, Turkey and Argentina shows us what happens when inflation (or hyper-inflation) destroys the ability of national currencies to hold value.
These countries may seem small, irrelevant and notoriously mismanaged, but going further back, there are contless examples of this happening with dominant powers, like the Roman and Byzantine Empires, who, despite their immense power on the world stage and centuries of totalitarian control, eventually destroyed their own currencies through the practice of monetary debasement. Back then they could not arbitrarily inflate the supply, as central banks do today, so instead they would, for example, simply decrease the amount of precious metals in each coin.
Recent studies (here and here) based on historical analysis, suggest that there’s less than a 2% possibility of a nation’s currency not being devalued once their debt to GDP ratio exceeds 130%, a position many of the biggest modern economies have already exceeded, or find themselves disconcertingly close to.
Satoshi identified this debasement as the root cause for the historical failure of currencies and in order to solve this problem he created a system of money where the supply was easily verifiable, where new supply was created according to a highly predictable pattern, and where a hard cap limit was placed on the eventual number of currency units, with the entire system being coded into a protocol that governs the network. A protocol which cannot be changed unless practically everyone in the network agrees to change it.
And to ensure that the system wasn’t built on trust, Satoshi designed Bitcoin such that anyone could verify, for themselves, the monetary supply and network rules. Thus Satoshi chose a design that made the creation and movement of all the currency units on the network completely transparent.
You can, quite literally, at any time, count up all the balances on all the addresses to verify the total supply of Bitcoin. And you can do this completely independently. In this way you can confirm for yourself that no one has ever created any extra bitcoin for themselves and that the the supply hasn’t been inflated wantonly.
It’s not that Satoshi did not want Bitcoin to be anonymous. He likely would have preferred to make it completely anonymous. Satoshi was a Cypherpunk, or at least that’s the community he first pitched the idea of Bitcoin to. Besides, he’s kept his own identity hidden all these years. It’s therefore very likely that he believed in digital privacy.
But he realized that for something to function as money, and fulfill that function properly and indefinitely, anonymity was secondary to a sound monetary policy. And the soundest monetary policy possible would be one that’s built around complete transparency of supply.
Privacy is a real concern in the digital age. Personal data is being exploited like never before. And the cypherpunk movement of the early internet days (of which Satoshi was likely a member) realized very early on that the digitization of information would make personal information vulnerable.
Decades before the creation of Facebook cypherpunks saw the immense potential of new digital technologies, but also the dangers it posed to privacy. They therefore advocated digital privacy through the use of cryptography and it was from within this ethos that Bitcoin emerged.
Digital privacy is therefore a high priority among Bitcoin developers, and besides the techniques mentioned earlier, there is a lot of work being done at the base layer of the protocol to improve default privacy on the Bitcoin network.
However, like Satoshi pointed out, the root problem with modern monetary systems aren’t their lack of privacy. The root problem is their trust based model which (eventually) is always exploited by heavily indebted governments, leading to the inevitable destruction of the underlying currency.
Privacy can therefore not come at the expense of an easily verifiable supply.
Thus the default setting in Bitcoin is not anonymity. First and foremost Bitcoin is a system of sound money.
In fact, one could go so far as to say that, at least initially, Bitcoin is a system of sound money precisely because it isn’t anonymous.
It is of course possible that default anonymity and supply transparency will one day co-exist in Bitcoin, and hopefully this can be accomplished, making it optional whether or not to reveal any transaction details.
But that is definitely not yet the case and in Bitcoin it likely won’t be, not until anonymity can be implemented without affecting supply transparency.