From its inception, the crypto industry has been built on anonymity. A decade ago, a mysterious figure under the pseudonym Satoshi Nakamoto created Bitcoin and ushered in the era of crypto transactions. Everyone was fascinated by the idea of making financial transactions without a third party such as the government or the bank.
Crypto transactions are recorded on decentralized ledger systems called blockchains that allow users to transact without a name or register an account with a bank or payment system. However, as the crypto industry has grown into a mainstream industry, many most especially, the banks and government are concerned about the supposed anonymity of crypto transactions. This issue has led to many central banks calling for an outright ban or strict regulations on crypto transactions.
Are crypto transactions anonymous? In this article, I will talk about the concept of blockchain and cryptocurrency, how crypto transactions work, and if they are anonymous or not.
Blockchain Technology and Cryptocurrencies
Blockchain is the technology that many cryptocurrencies today such as Bitcoin and Ethereum are built on. A blockchain network is a type of distributed ledger. A distributed ledger allows for record-keeping across multiple computers. These computers are referred to as nodes. Any blockchain user or computer can be a node. Within a distributed ledger, the nodes verify, approve and store data.
Blockchain technology is more like a digital form of record-keeping in contrast to the traditional form. The blockchain network organizes information that is added to a ledger into blocks or groups of data. Each of these blocks contains a certain amount of information and as new information is entered into the network, new blocks are continually added to the ledger, thus forming a chain. Each block has its unique identifier called a cryptographic hash. The hash not only protects the information within the blockchain network but also protects the block’s place along the chain by identifying the block that came before it. Information added to a blockchain is permanent and unchangeable and is encrypted.
Every node in a blockchain has its record with a timestamp. If someone tried to tamper with or hack into a computer and manipulate the data in a blockchain, it wouldn’t alter information stored in other nodes. The altered blocks can be easily distinguished and corrected since it doesn’t match the majority.
Combining public information with a system of checks and balances helps the blockchain maintain its integrity and creates trust among users. Essentially, blockchains can be thought of as the scalability of trust via technology.
Cryptocurrencies are digital assets that use cryptography, an encryption technique, for security. Most cryptocurrencies are primarily used as a store of wealth or used to buy and sell goods and services. Unlike traditional currency, they are not issued by a central authority and are not considered legal tender.
According to CoinMarketCap, there are well over 18,000 cryptocurrencies today. Some of them have no value whatsoever and some have made early adopters millionaires.
Today, thousands of blockchain transactions are happening daily. What’s the magic behind blockchain transactions?
The Theory Behind Crypto Transactions
A transaction, in its most basic form, is the transfer of value between two parties. In the context of cryptocurrencies, these transactions can be thought of as the exchange of crypto assets between users of the network. But in reality, all of these transactions are merely records stored within the blockchain network.
So crypto transactions are simple messages that contain information. Messages can be programmed and digitally signed using cryptography before being broadcast to the entire network for validation. This is why some see cryptocurrency as programmable money. Furthermore, because crypto network transactions are public, they can be easily found within your blockchain. And in it, every transaction since the creation of the first bitcoin can be verified.
Four elements make up a crypto transaction.
The first component is INPUTS. Entries are references to a previous transaction’s output that has not been used in any other transaction. These enable us to confirm the origin of the assets that will be used in a transaction. They also contain the address from which the crypto assets were originally received.
The second output ELEMENT contains the address to which the transfer is made as well as the amount shipped. They also include the direction of change or return, which is where the transaction returns are sent. As a result, a transaction can have multiple outputs.
The TRANSACTION ID is the third element. Each transaction will be assigned a unique hash. This hash is created by combining the inputs and outputs. This value is what allows us to identify a transaction in a blockchain in a unique and unrepeatable way.
The commission rate is the final element of any crypto transaction. The commission rate here is the transaction fee. This is a small payment that miners receive for processing a transaction. As a result, the miner who generates a new block will be compensated for each transaction processed within that block.
The commission does not appear explicitly in the transaction’s content, because the miner who will receive that fee is unknown. For this, what is done is to leave a certain amount without associating any output, and this will be understood as a commission for the miners.
Ever wondered how Bitcoin transactions are made?
How are transactions recorded and verified on a blockchain network? Here’s an example of how blockchain is used to verify and record a transaction.
● A transaction is made. An example is someone buying 1 BTC.
● The transaction data is sent across Bitcoin’s decentralized network of nodes.
● The nodes in the network validate the transaction.
● After approval, the transaction is grouped with other transactions to form a block, which is added to an ever-growing chain of transactions.
● The completed block is encrypted, and the transaction record is permanent; it cannot be removed or altered on the blockchain.
These steps have made sure that blockchain and crypto transactions are made with ease and with less supervision. However, there has been a debate that blockchain and crypto transactions are anonymous since no one can easily know the person behind each transaction.
This has been the reason most governments use when justifying the reason behind regulating or banning crypto transactions in their respective regions. Are crypto transactions as anonymous as most think?
Crypto Transactions are NOT Anonymous
Are crypto transactions anonymous? This is a question that most people wonder about. Since the inception of cryptocurrencies, there has been a major shift in financial movement from traditional means of transactions to digital means of transactions involving cryptocurrencies. However, most people believe that Bitcoin or other cryptocurrencies are anonymous. Why do people think that cryptocurrencies are more anonymous than normal currencies?
In contrast to cryptocurrencies, fiat currencies are being tracked by the government to an extent. The Central Bank of some countries tracks cash that leaves or gets into their countries. Also, the bank monitors and controls most fiat currency transactions. On the other hand, cryptocurrencies do not have a central authority like the banks. No one person, company, or government can control the supply or circulation of Bitcoin or any other cryptocurrency. Since there is no single body controlling cryptocurrencies, most central banks view crypto transactions as anonymous. However, is this theory true?
In a sense, crypto transactions are anonymous because it’s quite impossible to know the face behind a wallet address. However, cryptocurrency exchanges are addressing this issue by requiring a KYC ID before allowing you to conduct transactions. In other words, if your Bitcoin wallet is empty and idle, you are completely anonymous. However, if you have ever sent or received something, the KYC documents are uploaded to an exchange to identify both the sender and the receiver.
While Bitcoin wallet records are open to the public, there is no built-in system for determining who the owner is. Bitcoin does not require a ‘know your customer’ (KYC) identity proof for you to have a wallet. This is the origin of the myth of Bitcoin anonymity.
Several blockchain analytic firms, such as Chainalysis, have also developed tools that can significantly narrow the search. These tools search for relationships in transactions to assist businesses and law enforcement agencies in tracking criminals.
In the video below, Mental Outlaw showed how you can trace blockchain transactions.
However, crypto transactions are not anonymous. For all of the crypto’s abilities, anonymity is its greatest strength and also its greatest weakness. Cryptocurrencies are run on a public ledger. This means that transactions are recorded on a blockchain and are seen by all the nodes on that network.
Each transaction recorded on the blockchain network includes details such as amount, time, the sending wallet address, and the wallet that receives the crypto asset. Anyone can analyze transactions made by both the sending and receiving wallets. However, as long as there is no link between a wallet address and your identity, your transactions stay anonymous.
If a wallet address was to be connected to a particular identity then all your transactions are no longer anonymous. Let me give you an example. So many content creators today also use cryptocurrencies as an avenue for their audience to show support. I can run a blog and post my wallet address at the bottom of every article I write so those who read can show support if they want to.
Anyone who copies my wallet address associates that wallet address with my identity as the owner of the blog. Therefore it is easy to know the crypto transactions I have made. So would you say my crypto transactions with that address are not anonymous? The answer is NO. True anonymity is when transactions cannot be linked back to you.
The Right Word is Pseudonymous
Cryptocurrencies are pseudonymous rather than anonymous. According to Merriam Webster, being pseudonymous means bearing or using a fictitious name. Your wallet address is your name in the digital space and no one bears a name that has a string of 26–35 characters in it.
Sending and receiving virtual currency is similar to writing under a pen name. If an author’s pseudonym is ever linked to their identity, everything they’ve ever written under that pseudonym will be linked to them as well. Everything that happens in the Bitcoin world is traceable due to the way the algorithm is structured.
Because every transaction involving that address is recorded in the blockchain, if your address is ever associated with your identity, every transaction will be associated with you.
Does this mean that anonymity is impossible with blockchain transactions? To an extent, no. There are tools or mediums one can use to maintain anonymity:
Virtual Private Network (VPNs): Using a VPN service is essentially the same as using someone else internet connection. Companies that provide VPN services host massive servers that accept your internet connection and then route it through their IP address. You can hide behind their connection this way.
Use a Different Bitcoin Address for Each Transaction: This is a better option for those who do not want people to know their different transactions. Using different addresses makes it difficult for people to track the movement of your money. However, you must be careful so that you do not forget or lose track of the addresses or log-in details you use for each wallet address.
Tumblers and Mixers: This is similar to using a different address. When you use a tumbling or mixing service, your money is first sent to be mixed with the money of thousands of other people. It then appears from a completely different address and goes to your destination.
Privacy Coins to the Rescue
Privacy coins provide true crypto anonymity. Privacy coins are cryptocurrencies that protect users’ anonymity by masking the movement of money through their networks. They make it difficult to determine who sent what to whom — which is useful if you don’t want anyone peeping into your financial transactions. How do privacy coins function?
Privacy coins are standard cryptocurrencies. They do, however, run on blockchains that are maintained by an anonymous validator network. Privacy coins stand out from the crowd due to their advanced privacy techniques. Zcash, Monero, and Oasis Network are the three most valuable privacy coins in terms of market capitalization.
Monero is one of the few privacy coins that are always private. Unlike Zcash, you cannot disable its privacy features. Monero uses one-time-use stealth addresses for each transaction to hide transaction data; ring signatures which group genuine transactions with old “decoy” transactions to make it difficult to determine which transaction is legitimate; and ringCT which hides the amount of Monero sent in a transaction.
Zcash is a privacy coin with the added benefit of allowing for transparent transactions. Private transactions employ zero-knowledge proofs, which are a type of mathematical calculation that signals to the network that something is true — such as the validity of a transaction — without disclosing additional information about that transaction, such as the addresses and transaction amounts.
Is it true that privacy coins are truly private? They are, indeed. Despite the development of new analytical tools over time, they have proven to be resilient. However, as with Bitcoin, I doubt they will remain untraceable. Money is too important to be unregulated, so I predict that these privacy coins will eventually become traceable, and people seeking privacy — for whatever reason — will have to look elsewhere.
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