Are Bitcoin wallets anonymous? No, they are not. No Bitcoin wallet can be claimed to be anonymous, but some can be considered to allow transactions to be more traceable than others. Indeed, the more appropriate question would be ‘are bitcoin wallets traceable?’
Bitcoin wallets are not anonymous because Bitcoin itself is not anonymous.
But before we look at how different Bitcoin wallet applications might fair when it comes to traceability, and how your own actions is a factor, let’s first look at how and why Bitcoin and, therefore, Bitcoin wallets are not anonymous.
I know it might be confusing to hear that Bitcoin is not anonymous, especially if you are new to it and you’ve been told it is the digital currency of those who want to hide how they earn and spend their money.
In fact, the primary issue those who disapprove of Bitcoin have against it is that it can facilitate crime as users can easily hide their activities from law enforcement. That might be true, but it is not because Bitcoin is anonymous.
I am not a fan of Bitcoin and other Cryptocurrencies, which are not money, and whose value is highly volatile and based on thin air. Unregulated Crypto Assets can facilitate unlawful behavior, including drug trade and other illegal activity….
— Donald J. Trump (@realDonaldTrump) July 12, 2019
What does anonymity mean
The Google dictionary defines anonymity as the ‘lack of outstanding, individual, or unusual features; impersonality.’ This cannot be said of one’s presence and activity on the Bitcoin blockchain (the shared public ledger).
You definitely have outstanding, individual and unusual features through your public address (public key) when you send and receive bitcoins. There are no two public addresses that are the same. Each address is unique and is like no other. I could extend it further and say that hardly any two Bitcoin transactions are the same, especially considering a bitcoin is divisible up to 8 decimal points.
If Bitcoin were anonymous, you wouldn’t have a unique identifying piece of data (an address) you give those who need to send you bitcoins.
Also, even in other aspects of the internet, achieving total anonymity is almost impossible. At any point, we seem to need some unique identifying tag. Even when you browse the net incognito, your IP address remains as a critical identifier.
When you hear someone call Bitcoin anonymous what they really mean is that it is pseudo-anonymous.
The difference is significant.
What is pseudo-anonymity?
Pseudo-anonymity is a status achieved when you create a (mostly online) identity that is not linked directly to your real-world or legal identity. It is one way to preserve your privacy.
For example, when one wants to use an email address that cannot be linked back to them (for whatever reason), they use made up names and place holder fake personal data to create one. What they end up having is a pseudo-anonymous email account.
They might use this identity to interact with others who they might not want to know who they indeed are or use it to create pseudo anonymous accounts on other online platforms.
That means they can send and receive messages without having to disclose their legal identity. True anonymity can only be achieved where you do not need to create any kind of profile (address) to use a service.
In the case of Bitcoin, and other cryptocurrencies, you use a pseudo-anonymous identity to send and receive digital currency. The idea is to get the experience of physical currency online. When you give out a $20 bill at the store, nothing on it indicates it came from you.
Meanwhile, if you make payment using PayPal, internet banking, or any other centralized digital payment method, there is always a trail leading to your doorstep. If their servers are hacked or they are under duress from the government to share data, your privacy regarding your finances is exposed to third parties.
That is because you have to sign up for their services using your legal or real-world identity. The signup process often includes submitting a legal document to prove your identity. You may also have to share your postal and physical address.
Money spent on the Internet through centralized payment systems like PayPal or Internet banking lacks fungibility, an essential feature of money. One unit of the money might not be considered to be the same as another unit of the same amount or value.
That is because every piece of money is tainted by the path it takes and in particular the people who have owned it. Its history becomes a critical part of it.
Pseudo-anonymity or anonymity, where it is achieved, attempts to delink digital money from its history, path, and the activities of those who have owned it in the past. Just like the physical cash is not necessarily tainted by the path it has taken and the hands it has gone through.
The reason why you cannot create a pseudo-anonymous account on PayPal or with your bank is that these are registered business entities that must abide by regulatory requirements.
In particular, they have to meet the Know Your Customer (KYC), Anti-Money Laundering (AML) and terrorist financing legal framework requirements. And these demands are typical in nearly every country on the globe.
Meanwhile, Bitcoin is a decentralized payment method. It is not in the control of a particular person or company. As the co-founder of asset management firm Morgan Creek Digital, Anthony Pompliano, stated in response to the infamous Trump tweet about not being a fan of Bitcoin, “With Bitcoin, there is no CEO. You can’t send a letter or send somebody in for a hearing.”
— CNBC (@CNBC) July 12, 2019
In other words, there is no way to force Bitcoin to register its users using their legal or real-world identities. If that was the case, and it happened, centralized payment methods like PayPal would be way more private than Bitcoin because they do not publish the transaction ledgers for the public to see.
The identity you use on the Bitcoin ledger (blockchain) is a string of between 26 and 35 random letters and numbers. It is hard to memorize this identity (address). The Bitcoin protocol determines its shape and format. You have little say as what your public address should look like and the characters it should contain. The wallet application you are using randomly generates it for you.
There is a push for human-readable public addresses though. Proponents of this feature believe it will make using Bitcoin easier, especially since you wouldn’t need only to copy paste or scan the address to share it. You will have the option to spell it like you do an email address. This has, however, only been tested on a few altcoins.
A Bitcoin wallet address is normally known only to you until you share it with the person you want to send you bitcoins. And when they send the bitcoins, it will be published on the blockchain as a recipient of funds from the sender’s own public address.
The rest of the community will see on the addresses and the amount sent. However, it is only you and the sender who know the faces behind the addresses.
But that is not to say that attempts are not made to unmask those behind Bitcoin transactions. Some factors make it easy for transactions to be traceable, and one of those is the type of wallet application you use.
That means third parties could find it easier to figure out the real-world identities of people involved in a transaction if the counterparties use particular wallet applications. This is especially the case if the sender fails to put in place necessary privacy safeguards.
It is important to emphasize that how you use any wallet application is an important factor as to whether your transactions can be linked back to you or not.
Delinking address and real-world identity.
As we’ve seen, you need an address on the blockchain to use bitcoin. It is vital that this pseudo-anonymous identity is not linked to your legal or real-world identity.
Your privacy with using Bitcoin is guaranteed as long as third parties are not able to link your transactions to your name.
Delinkage of your bitcoin transactions from your real world is always under threat. There are those who are really interested in knowing who is behind a Bitcoin transaction, and for various reasons.
Government agencies might want to know as part of monitoring possible criminal activities such as money laundering and terrorist financing. The government is also interested in this data because it wants to see if you are paying due taxes.
On the other hand, criminals might also be interested in linking your blockchain address and your real world so that they can attempt to phish you and social engineer you so that they can collect your private keys to steal from you.
Businesses might want to get hold of this data so that they can target you with ads and sales offers.
Things that make you vulnerable.
There are several things you might do or fail to do that make you vulnerable. For example, if you create an account on an exchange and you are required to verify your identity, then the likelihood of someone attaching your name to the bitcoins you buy from that exchange is very high.
In fact, there are now for business entities engaged in doing surveillance and analysis of the transactions on the blockchain to determine the real world identities of senders and recipients.
One of those entities is Chainalysis, a company founded in 2014 to help law enforcement and companies track the movement of Bitcoin and highlight crime tainted transactions.
To counter-surveillance on the Bitcoin blockchain, users have access to a few tools. One of these is mixers, online pools where transactions are taken through and given new IDs so that they shake off any trail.
Unfortunately, many of these services are centralized, and therefore, they are vulnerable to being shut down. In fact, a few have been forced to shut down in the recent past. In late May 2019, Dutch Financial Criminal Investigative Service shut down BestMixer.io.
Over time, since the launch of Bitcoin, we’ve seen the rise of cryptocurrencies that can be described as near anonymous. The most known of these is Monero and ZCash.
The transactions of these decentralized currencies are not published on the shared ledger in a way that all details such as source and destination address, amount and time are visible to the public. The technology they use has allowed the networks to confirm the authenticity of transactions without accessing these details.
Now, how do wallets factor into this?
The question ‘can bitcoin wallets be traced?’ needs some unpacking because the answer has to be nuanced.
It is important to note that there tens of types of Bitcoin wallets that you can use.
Each of these types of Bitcoin wallets is designed with unique features, capabilities, and architectures. These determine in a significant way whether that particular wallet makes your transactions easily traceable or not.
Also important is who designs and manages a wallet application. In particular, the control they have on how it works and their access to the data the wallet application generates.
Some wallet service platforms are offered and managed by for-profit centralized entities such as exchanges. For example, Coinbase, the largest crypto exchange in the US, provides a wallet service. Meaning you can create and run a Bitcoin wallet on their platform.
Some wallet applications are entirely open source community projects. Meaning no one entity is in charge or in control to harvest data.
The potential of traceability is high with Coinbase wallet, in particular, because they require users to verify their identities to use some of their services.
For example, using Electrum wallet on your desktop, an open source wallet application with no attached services that require you to identify yourself, has a lower potential of your transactions being traced.
Ideally, as a Bitcoin user, you should use a wallet that you have full control of. In particular, it should be a full-node wallet application installed and running on your local computer.
A wallet you access through a browser or a mobile application is most likely relying on a service by a third party, a situation that increases the possibility of traceability.
Another factor that might make one wallet more traceable than another is the ability to generate new wallet addresses.
As a precaution, Bitcoin users are encouraged to use one address for a single transaction. That means for every payment you receive, you should create and provide a new address to whoever is sending you Bitcoins.
While possible, using a single address for multiple transactions makes it easier for whoever is trying to identify your activity on the blockchain to link them to you. And this situation doesn’t expose only you but also those who transact with you.
Some wallet applications might have a robust mechanism for wallet address generation every time you want to receive bitcoins and others might be designed in a way that you will find yourself using the same address several times, thus increasing the chances of someone linking your transactions to your real life identity.
So, can bitcoin wallets be traced?
It depends on the following factors:
The type of wallet application
The exact kind of wallet you are using. Whether it is open source or offered by a third party. And whether it has inbuilt privacy features such as automated address generating system. You should use wallets from the list provided by the Bitcoin.org, the project’s official website.
How you use the wallet application
The second factor is how you are using the wallet application. Are you using it on a secure device? Do you use a new address for every transaction and do you adequately protect your private keys by keeping them in cold storage.
Where you use your wallet
The third factor is where you use your wallet. Do you use your wallet to get services that require you to identify yourself? Do you shop using your bitcoins on a site where you need to leave your identity or buy bitcoins from an exchange that requires you to verify your identity?