One of the apparent contradictions of Bitcoin is the notion that your transactions can be private but have a public transaction record. In this section, you’ll learn how you can use Bitcoin to keep your finances private.
Why it is important to keep your funds private
As a financial system, Bitcoin functions completely differently from the established banking network. Bitcoin allows you to store funds yourself, without the need for a third party, and therefore places the burden of keeping said funds secure and accessible on you.
While opening an account with a traditional bank or other financial institution requires significant cost and effort, creating a Bitcoin account is quick and easy to do on your home computer. This speedy process makes it possible to create hundreds of separate accounts if you wish.
Two aspects in particular—privacy and identity—function very differently with Bitcoin than in the legacy financial system.
Pseudonyms protect your identity in Bitcoin
A bank account, PayPal account, or credit card is always tied to a real identity, making it difficult for many people to open them. Bitcoin allows you to use any persona or online identity you wish.
Being able to use the internet anonymously or pseudonymously is the only way for many people to truly be themselves. Hundreds of millions of people around the globe are not accepted in their societies for reasons they cannot control.
Pseudonyms are used by women speaking up for their rights, atheists living in religious societies, and people critical of their governments to spread their thoughts, empower their causes, and encourage those around them to do the same.
These courageous men and women put their own safety and well-being at risk to defend who they are and what they believe in. Technology empowers them to become leaders of social change in societies by providing this very pseudonymity. Technology also connects like-minded individuals so they can form the communities for which they strive.
Maintaining an identity with a large following might require paid services such as blogs, logo designs, stock photos, VPNs, or translations. Without the ability to pay for these services anonymously, you would be forced to reveal your true identity in order to maintain your pseudonym situation which clearly makes no sense, and one with potentially dangerous ramifications.
- Also take a look at the best VPN services (opens in new tab)
How Bitcoin empowers anonymity
Bitcoin is an important, empowering technology. Using a Bitcoin account with a pseudonym protects your right to remain anonymous on the internet. It allows anonymous or pseudonymous fundraising. Groups can collectively control Bitcoin accounts and choose to either hide or reveal financial information at will.
There are many positive reasons for a private and secure banking system like Bitcoin.
For example, a workers’ rights group could raise funds with Bitcoin. The money could be used for servers, flyers, remote helpers… and all without tying any transaction to the real identities of the volunteers.
Likewise, a domestic abuse victim might use Bitcoin to securely stack away funds to prepare for an independent life.
Privacy through pseudonymous accounts
Privacy in traditional banking is guaranteed by the institutions that make up the system, such as banks, credit card companies, and governments. They (try to) ensure that your bank balance stays a secret. This puts them in a powerful position, where only they have complete oversight as to what is going on.
In the Bitcoin ecosystem, everyone can see the history of every account balance, but they cannot see who controls an account. All addresses and transactions are recorded in Bitcoin’s publicly distributed database, the blockchain (opens in new tab). The addresses do not have names or IP addresses attached to them, so it is not always possible to know which transaction belongs to which individual.
Transparency requires protection
Bitcoin is by default a transparent system, in which every piece of information is available to the public. As such, every Bitcoin user requires some level of protection. Anyone with substantial wealth in Bitcoin would not want to advertise their funds to every person they transact with, for obvious reasons. But every time you spend just a tiny portion of your Bitcoin wallet, you reveal your wealth to the other party. Doing that on the internet is like flashing large stacks of cash in a dark back alley, so obviously it’s not advisable! A criminal might see how much you have and decide to come after it. Distributing your wealth between several wallets and using a different address for each transaction is a common practice that prevents others from knowing how much Bitcoin you have.
The traditional privacy model and the new privacy model as explained by Satoshi Nakamoto in the original Bitcoin Whitepaper.
How you can be de-anonymized using Bitcoin
Sadly, there are hundreds of ways a Bitcoin transaction can be linked to someone’s real identity. True pseudonymity against a resourceful adversary is very difficult to achieve. Any sincere approach to anonymity in Bitcoin requires a holistic use of encryption and communication tools.
Over the course of just a few months, you could come into contact with hundreds of Bitcoin addresses. It is often only necessary to associate just one of these addresses with your real identity to work out your real identity.
Bitcoin is traceable on the blockchain
Each Bitcoin transaction contains at least one input (where the Bitcoin are from) and at least one output (where the Bitcoin are being sent). This means that once a single address is known, there is a trail to follow the Bitcoin.
Another characteristic of Bitcoin transactions is that they always need to match the previous transaction. If you previously received 1 bitcoin, but you only want to spend 0.4 Bitcoin, you will first need to make a transaction where 1 bitcoin will leave your account. 0.4 bitcoin will go as payment, then 0.6 bitcoin will return to you as change. Your Bitcoin wallet will handle this process automatically, but it is important to understand the principle in order to use it anonymously.
The owner of the original Bitcoin doesn’t know what you did with the money, but they can see the amounts involved. They can see two transactions on your account: one for 0.4 bitcoin and one for 0.6 bitcoin. They cannot see which was the purchase and which is the “change,” but it’s a 50% guess. The next time you make a transaction, it’s a 25% guess, and so on.
This is why making lots of transactions, even between yourself, increases your anonymity in the Bitcoin network (as long as your wallet software does not reuse addresses!).
Similarly, if you receive 0.5 bitcoin but want to spend 1 bitcoin, you need to own additional Bitcoin addresses with a combined value of at least 0.5 bitcoin in them. Again it’s a 50% guess, but now you have one extra publicly visible Bitcoin address. Having publicly visible Bitcoin addresses could make it easier to find out your identity.
Your name might be linked to your Bitcoin address
Your real name might be connected to a Bitcoin transaction when you make transactions with Bitcoin, for example, if you buy goods online and have them shipped to your real address. Bitcoin exchanges (opens in new tab) and even some ATMs often require you to show identification before making a purchase. When you buy Bitcoin from someone in person, they might know who you are and keep a record of the transaction. This record could fall into the hands of your adversary, or maybe even be made public.
Your country’s anti-money laundering laws might require you to reveal your identity when buying or selling Bitcoin, making it necessary to obfuscate your trail on the blockchain to protect your anonymity.
Your IP address might be linked to your Bitcoin address
When you make a Bitcoin transaction, you are essentially creating a message on your phone or computer and sending it to the Bitcoin network. Someone operating a large number of nodes in the Bitcoin network might be able to match some of your transactions to your IP address, then deanonymize your entire stack of Bitcoin.
It is relatively easy to avoid this on a computer by relaying all transactions through the Tor network. Most Bitcoin clients and wallets support Tor’s SOCKS5 proxy.
Revealing your Bitcoin address before it goes into the blockchain could let others track you
As soon as a Bitcoin address is entered into the blockchain, it is publicly recorded in an immutable global database. Before that happens, it’s likely that only two parties—the recipient and sender—had knowledge of this address. If you are making a search for an address that has not yet appeared on the blockchain, either you are the owner of this address, or someone is requesting a payment from you.
To avoid being tracked in this way, it is important to make all payment requests and other mentions of addresses via encrypted channels:
- Make sure the website you are visiting has HTTPS enabled when you search for Bitcoin addresses
- Use VPNs and Tor when possible
- Encrypt your communications with PGP (emails, files and text) and OTR (chats)
Possessing a wallet file might be enough proof that you control Bitcoin
A signed message is the only strong proof that you own a Bitcoin address without revealing the private key. Be careful when signing messages using your Bitcoin keys, though. Signed messages are a great feature (we’ll talk more about why later), but they allow anybody to know that you control the Bitcoin address you signed from.
If someone is trying to de-anonymize you, they might be satisfied with a weaker form of proof than a signed message: Knowing that you keep records of public addresses is enough evidence for someone to draw the conclusion that you are involved in Bitcoin transactions and the Bitcoin blockchain will point them exactly to which transactions. All they have to do is search for the address you recorded.
Most wallet software store public addresses without encryption, only encrypting the private keys. This is good for user experience, since you don’t have to type in a password every time you want to see your balance or check transactions.
You can safely store your wallet in an external USB drive, a cloud storage service, or even your email account if the private keys are sufficiently encrypted. But anybody with access to these mediums could estimate what addresses you control and the transactions you make.
To protect yourself, you should encrypt all backups with a second password or PGP.
How to be transparent
The concept of privacy is best defined as the extent of control you have over your information. This control not only includes the power to hide or conceal your personal information, but also the power to reveal it to the public. Transparency is useful if you need to gain legitimacy in the eyes of your audience or backers. Bitcoin allows you to be transparent to any degree you like. You can use it to prove single transactions or ownership of a Bitcoin address. Transparency also allows you to audit your organization down to the last Satoshi (the smallest unit of a Bitcoin), without revealing your real identity or location.
When compared to traditional financial systems, Bitcoin’s transparency is an important and empowering innovation because it allows you to prove beyond doubt that you made a transaction of funds. The blockchain does not lie, and it cannot be bribed.
Transparency via signatures
The simplest form of Bitcoin transparency is to link two identities by signing statements. How you do this depends on your specific wallet software, but the principle is always the same. You write up a statement and then sign it digitally with your private key. This will not necessarily prove that the statement is true; it only proves that the owner of the address made the statement.
For example, if the operator of a website claims they control a Bitcoin address in their statement, and the owner of the Bitcoin address claims they are the operator of the website in their statement, you can reliably conclude the two are the same entity. You can then send funds to the Bitcoin address, safe in the knowledge that it is going to the right website.
You can also use these signatures to make statements about some of your transactions. For example, you might need to prove to auditors that you made a transaction, or that you control a certain amount of funds.
This is very useful for unforgeable, digital receipts. With just a few clicks you can prove to an art dealer that you are in possession of enough funds to purchase a painting, or maybe show your investors that you are still in control of their money.
Transparency via reused addresses
The official Edward Snowden Defense Fund uses a static Bitcoin address for its Bitcoin donations. This shows how many Bitcoin they have raised, and gives backers assurance that they are not being duped into donating to someone claiming to be collecting money on behalf of the defense of Snowden.
This level of transparency can be used anywhere, to prove that funds are not being embezzled and money is being spent responsibly.
Lexie M writes about information security, bitcoin, and privacy. She is excited about empowerment through technology, space travel, and pancakes with blueberries and blogs for ExpressVPN who is TechRadar’s number one VPN provider (opens in new tab). This is an excerpt from Lexie’s eBook called “Bitcoin Security and Privacy : A Practical Guide” which is free to download on iOS, Android, Kindle Kobo and Nook (opens in new tab).