No, Cryptocurrency is Not Anonymous: It is Pseudonymous

One of the guiding principles of the blockchain is that it is a public ledger that’s shared and everyone with a little bit of computing power has access to it, including law enforcement. So the secret service hasn’t been doing anything that wasn’t the original intent of the blockchain. We’re just using the same tracking and tracing mechanisms that were intended,

– noted Smith.

He added:

when you follow a digital currency wallet, it’s no different than an email address that has some correlating identifiers. Once a person and another person make a transaction, and that gets into the blockchain, we have the ability to follow that email address or wallet address, if you will, and trace it through the blockchain.

For many crypto enthusiasts, especially those new to the space, Smith’s revelation might come off as shocking. Especially since Bitcoin, which emerged after the 2007-2008 financial meltdown that exposed the vulnerability of the traditional financial system, has always been associated with privacy and anonymity, highlighted in the 2009 Satoshi Nakamoto’s seminal whitepaper.

The notion of an anonymous, privacy-based monetary system powered by disruptive technology like blockchain spoke to many people worldwide, many of whom had been taken aback by the scale of state surveillance in the U.S. and beyond, exposed by the famous whistleblower Edward Snowden in 2013.

In reality, however, Bitcoin has never been fully private or anonymous. Nor was it poised to be that by design.

Inherently pseudonymous, all it does is veil your identity during a transaction, which can be disclosed at any time by others or yourself thanks to the publicly available link between the sender and the receiver. While the ordinary folk – except your next-door geeky neighbor – are most likely incapable of connecting movements to different wallets, authorities and services like Chainalysis Inc., which regularly combs through transactions to help law enforcement in helping to identify the perpetrators, are able to do so.

Because of this traceability, many users – both with benign and not so benign intentions – use methods like mixers, which break up Bitcoin into many smaller transactions and jumble them with other transactions to make the process as daunting, cumbersome, and complex as possible for those willing to track their movements.

Although this helps add a layer of anonymity to bitcoin transactions, it does not guarantee full privacy. For example, Heather “Razzlekhan” Morgan and Ilya “Dutch” Lichtenstein, the couple from New York who tried to hide the source of almost 120,000 bitcoin stolen during the 2016 hack of the Bitfinex cryptocurrency exchange used an array of complex series of transactions for obfuscating the BTC movements.

Still, the authorities managed to link them. After six years of arduous work, the Justice Department indicted the couple for their crime gone wrong.

Cryptocurrency’s anonymity is further undermined by the low liquidity of Bitcoin. Since most users want to cash out, at some point they will have to reveal their identity, creating a distinct paper trail.

Is any crypto really anonymous?

Some altcoins, also known as privacy coins, claim that, unlike BTC, they guarantee a full level of anonymity. Such as Monero (XMR), Zcash, Oasis Network (ROSE), Secret (SCR), Decred (DCR), and others.

Monero, for example, promises its users a public distributed ledger with privacy-enhancing technologies for obfuscating transactions. As a result, third parties purportedly cannot decipher addresses trading Monero, transaction amounts, address balances, or transaction histories. Thanks to these features, one day after the U.S. Treasury announced that starting in 2023, crypto transfers above $10,000 should be reported to the tax office, its price increased to $316 per coin (now it is trading at around $250).

Meanwhile, Zcash claims that it gives you the option of confidential transactions and financial privacy through shielded addresses, explaining that “Zero-knowledge proofs allow transactions to be verified without revealing the sender, receiver, or transaction amount. Selective disclosure features within Zcash allow a user to share some transaction details, for purposes of compliance or audit.”

While it is admittedly more difficult to trace privacy-based coins, it is still not impossible. A 2020 analysis titled “Alt-Coin Traceability” that compares Zcash and Monero showed mixed results, with the authors noting that “results show that introducing strict security and anonymity requirements into the cryptocurrency ecosystem makes the coin effectively untraceable, as shown by Monero. On the other hand, Zcash still hesitates to introduce changes that alter user behavior. Despite its strong cryptographic features, transactions are overall more traceable.”

One of its authors, Ruiqi Hu, added that “We know that, through forensics analysis, we can always get to the bottom of it. So, just to put this straight out, any cryptocurrencies claiming that they're 100% anonymous, we have to take it with a grain of salt.”

Besides, companies like CipherTrace are already working on developing techniques for providing financial investigators with analysis tools, targeting Monero’s traceability in particular.

Unless you are planning a crypto heist of the Ronin network scale and planning to sell some drugs on the darknet, the fact that your transactions are publicly visible and linked, even when using privacy-based coins, might not necessarily be irksome.

However, if you are an avid fan of all things anonymous, then the only thing you can do for the time being is test more coins, enjoy pseudonymity and mixes, and wait for new, privacy–based solutions to hit the market.