From its inception, the crypto industry has been built on the assumption that it promotes 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.
Introducing Blockchain and Cryptocurrencies
Many cryptocurrencies in use today, including Bitcoin and Ethereum, are based on the blockchain technology. A distributed ledger is one that uses a blockchain network. A distributed ledger enables the maintenance of records on several machines. These computers are referred to as nodes. Any computer or blockchain user can operate as a node. The nodes in a distributed ledger verify, sanction, and store data.
In contrast to the conventional method, blockchain technology is more like a digital form of record-keeping. The blockchain network organizes data that is added to a ledger into blocks. As fresh data is added into the network, new blocks are continuously added to the ledger, producing a chain. Each of these blocks holds a certain quantity of data. Each block has its unique identifier called a cryptographic hash. By identifying the block that came before it, the hash protects not only the data inside the blockchain network but also the block’s position on the chain as a whole. A blockchain stores encrypted data that is both permanent and immutable.
Each node in a blockchain has a timestamp for its record. Information stored in other nodes would remain unaffected if someone attempted to tamper with or hack into a computer and change the data in a blockchain. Since the changed blocks don’t match the majority, they can be easily identified and fixed. The blockchain can preserve its integrity and foster user trust by fusing open data with a system of checks and balances. Blockchains are essentially the scalability of trust through technology.
There are currently well over 18,000 cryptocurrencies, according to CoinMarketCap. Some of them are completely worthless, while others have earned billionaires out of early adopters. Thousands of blockchain transactions go place every day right now. What’s the secret to transactions on the blockchain?
How do Blockchain Transactions Work?
The exchange of value between two parties constitutes a transaction in its most fundamental sense. In the context of cryptocurrencies, these transactions can be thought of as the exchange of crypto assets between users of the network. However, all of these transactions are really just records that have been saved on the blockchain network.
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. Additionally, since crypto network transactions are visible to everyone, your blockchain may readily include them. Additionally, it allows for the verification of all transactions made since the first bitcoin was created.
A crypto transaction is made up of four components.
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.
You make a transaction of, let’s assume, 1 BTC. The transaction data is sent across Bitcoin’s decentralized network of nodes. The nodes in the network validate the transaction you’ve made. Once the transaction is approved on the network, 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.
Blockchain and crypto transactions are made with ease and with less supervision. However, there has been the 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?
Are Crypto Transactions Really Anonymous?
Are cryptocurrency transactions anonymous? The majority of individuals ponder this question. Since the inception of cryptocurrencies, there has been a significant shift in financial activity away from traditional means of exchange and toward digital exchanges including cryptocurrencies. But the majority of people think Bitcoin and other cryptocurrencies are anonymous. Why are cryptocurrencies perceived as being more anonymous than traditional currencies?
Well, unlike cryptocurrencies, fiat currencies are monitored by the government. Some nations’ central banks keep track of the money that leaves or gets into their countries. The bank also keeps an eye on and regulates most transactions using fiat money. However, unlike banks, cryptocurrencies do not have a central authority. Nobody controls the supply or circulation of a cryptocurrency. This is why most authorities think crypto transactions are anonymous. However, is this theory true?
Since it’s very hard to identify the person behind a wallet address, cryptocurrency transactions are in a sense anonymous. To combat this problem, most crypto exchanges now make you provide a KYC ID before allowing you to perform transactions. In other words, you are entirely anonymous if your Bitcoin wallet is empty and inactive.
Although the public has access to Bitcoin wallet information, there is no internal mechanism for identifying the owner. You can have a wallet for Bitcoin without providing a “know your customer” (KYC) identification verification). This is the origin of the myth of Bitcoin anonymity.
Several blockchain analytics 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.
Cryptocurrency transactions are not anonymous, though. For all of the crypto’s abilities, anonymity is its greatest strength and also its greatest weakness. Public ledgers are used to manage cryptocurrencies. This indicates that transactions are visible to all network nodes and are recorded on a blockchain.
The amount, time, wallet address that sent the cryptocurrency, and wallet address that received it are all included in every transaction that is recorded on the blockchain network. Anyone can analyze transactions made by both the sending and receiving wallets. However, your transactions remain anonymous as long as there is no connection between a wallet address and your identity.
Your transactions are no longer anonymous if a wallet address is linked to a specific identity. I’ll use one as an illustration. Today, a huge number of content producers offer their audiences a way to support them by using cryptocurrency. I can own a blog and put my wallet address at the end of every piece I write so readers may donate if they so want.
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.
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. So if crypto transactions are not anonymous, what are they?
The Right Word is Pseudonymous
Cryptocurrencies are pseudonymous rather than anonymous. Being pseudonymous, according to Merriam Webster, refers to having or using a false identity. In the digital world, your wallet address serves as your identity, and nobody goes by a name that is made up of a string of 26–35 characters.
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 trackable due to the way the algorithm is structured.
If your address is ever linked to your identity, every transaction using that address will be linked to you since every transaction involving that address is documented on the blockchain.
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.
How Can You Maintain Anonymity When Making Crypto Transactions?
There are several ways one can maintain anonymity when making crypto transactions. One of such methods is with the use of virtual service providers (VPNs). Using a VPN service is essentially the same as using someone else’s 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.
Another method you can use is taking advantage of 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.
The last method which is the most popular is transacting with privacy coins. Privacy coins provide true crypto anonymity. By hiding the flow of money across their networks, privacy coins shield their users’ identities. When it comes to your financial transactions, they make it tough to track who sent what to whom, which is good if you don’t want anyone prying into them. How do privacy coins work?
Privacy coins are like your normal cryptocurrencies. However, they do operate on blockchains that are managed by an anonymous validator network. The cutting-edge privacy measures used by privacy coins make them stand out from the competition. The three most valuable privacy currencies in terms of market capitalization are Zcash, Monero, and Decred.
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.
Monero is one of the few privacy coins that are always private. You cannot turn off its privacy features, unlike Zcash. Monero uses ring signatures, which combine genuine transactions with previous “decoy” transactions to make it difficult to tell which transaction is legitimate, one-time-use stealth addresses for each transaction to hide transaction data, and ringCT, which conceals the amount of Monero sent in a transaction.
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 trackable, and people seeking privacy—for whatever reason—will have to look elsewhere.
In summary, crypto transactions can offer a certain level of anonymity. Maintaining this anonymity and carrying out untraceable transactions is getting harder with the new KYC regulations, though. These days, frozen wallet incidents are also fairly common. The chances of someone tracking your account, finding out who you really are, or freezing your account are quite slim. These jobs need specialized equipment and expertise, and frequently include law enforcement authorities looking for criminals. It’s only a matter of time.