Tracking transactions: How anonymous is Bitcoin? - Luno (2024)

Earlier this week, news outlets reported that HM Revenue and Customs (HMRC), the UK’s tax authority, is looking for a blockchain analytics tool. The tax agency is offering £100,000 for software that can identify those who use crypto for purposes such as “tax evasion and money-laundering.”

“Many of these crypto-asset transactions are recorded publicly in a ledger known as a blockchain. Whilst the transactions are typically public, the participants undertaking them are not,” said HMRC.

“Crypto assets, such as Bitcoin and Ethereum, provide a means to transfer value between interacting parties,” they continue. “[…] These services are increasingly used for a range of purposes, from international money transfers, sales of digital services, paying staff, and tax evasion and money laundering.”

The move is not surprising and tax authorities wouldn’t be doing their jobs if they didn’t try to recoup all taxes owed them. But, it does raise an old but important question: How anonymous are Bitcoin and other cryptocurrencies?

An image problem

The public image of Bitcoin in the years that immediately followed its release was that of a tool used by international criminals. Its use on dark web marketplaces such as Silk Road meant the two were often conflated in both the media and people’s imaginations.

Since then, much has been done to correct this misconception. As crypto has moved into the mainstream and knowledge around how it works has increased, the impression has faded.

This is because, if anything, quite the opposite is true. Bitcoin is arguably the most transparent payment method ever developed. If anything, it has the potential to become a powerful tool in the fight against financial crime.

Is Bitcoin anonymous?

Let’s start by correcting a common error. Bitcoin is not anonymous by design. It is, rather, pseudonymous. In Bitcoin, your pseudonym is the address to which you receive Bitcoin. Every transaction and the wallet addresses involved are stored forever in the public blockchain and are visible to anyone who searches.

The addresses alone don’t reveal any identifiable details. However, they do provide a foothold for further investigation. Imagine your bitcoin address like an email address or an online alias: how hard it is to trace to your identity depends on what you do with it. With forensic analysis, any Bitcoin address used in a transaction is very likely to be traceable.

How it’s done

Any Bitcoin transaction you make with a party that knows your identity leaks information. This information can be used to identify your activity, past and future, on the blockchain. For example, say you buy a hat through an online retailer. You will likely give them your address so it can be delivered.

Your identity could also be traced if you are using a private WiFi connection. We generally have to give proof of ID to set up WiFi. Through this, your identity can be matched against your IP.

In a similar vein, say you publicly share your Bitcoin wallet address somewhere, such as a forum. Even if it’s not shared with any identifiable details, you may have used the same username somewhere else. You may have shared identifiable details in another post under that username. Someone can then track these by looking through your posting history.

It’s especially important to note that because you can see all transactions that take place over the Bitcoin network, multiple Bitcoin addresses can be grouped together. They can then be tied to the same address. Therefore, if just one of these addresses is linked to a real-world identity through one or several of the other de-anonymising methods, all of them can be.

So everyone is watching my every transaction?

In short, no. If you’re buying something, the merchant is highly unlikely to bother tracing you, and to do so would be costly.

Bitcoin essentially provides a paper trail that can be used by law enforcement agencies. Find out who one bad actor is, you can trace partners they’ve transacted with.

This traceability also makes Bitcoin theft a far less attractive endeavour. Bitcoin thieves are often unable to do anything with them, because, in most cases, they have been identified on the blockchain. They are forever “tainted”, sprayed with a kind of virtual blue-dye, similar to that used to protect from physical money-related robberies.

There are a number of firms out there that offer software to deanonymise Bitcoin addresses, such as Chainalysis, Elliptic, and CipherTrace. Chainalysis, for example, helped the FBI identify two rogue agents who had been stealing Bitcoins from the wallet of an online drug market operator.

There are cryptocurrencies out there that place a greater emphasis on privacy. HMRC might be out of luck when tries to track those working with more anonymous cryptocurrencies such as Monero and Zcash, who use a technology called zero knowledge proofs to prevent anyone from seeing where a Bitcoin has been. Ultimately though, when it comes to Bitcoin, HMRC shouldn’t find it too hard to find a company that can take their contract, though there will always be loopholes for criminals to abuse.

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