Privacy vs. Transparency: How Are Bitcoin Transactions Traceable?

Bitcoin and other cryptocurrencies used to be perceived as untraceable, offering users total privacy and anonymity. However, that is not the case; you can track bitcoin transactions. Your transactions are done to and from your bitcoin wallet, a pseudonym allowing you to transact within the network without revealing your true identity. Therefore, cryptocurrency is far from anonymous but rather pseudonymous. So, what makes them traceable?

Tracing the Untraceable

Bitcoin and other cryptocurrencies are moved around much like any other currency. The only difference is that no single authority, say, the government oversees its operations. But this doesn’t mean they are free from scrutiny. Every transaction is logged and publicly recorded on the blockchain.

Every bitcoin shared and passed around can be traced back to its origins. The blockchain only records public addresses but not the real users’ identities. This recording system is what makes any cryptocurrency pseudonymous and by no means anonymous.

How are Bitcoin Transactions Made Traceable?

The bitcoin network may evade regulators' radar, but cryptocurrency service providers, such as crypto exchanges, cannot. Most of these service providers are required to implement Know-Your-Client (KYC) protocols. These protocols link crypto users' identities to their addresses or bitcoin transactions.

Bitcoin Transactions and How They're Traced

Thanks to the blockchain’s publicly available ledger, just about anyone can do surface-level tracing with the help of blockchain explorers. However, digging deeper becomes more difficult as some addresses are harder to track. Criminals, for example, do all they can to mask their trails by creating multiple addresses and wallets.

How Crypto Users Lose Anonymity

Most crypto users will have to disclose their identities eventually. For example, if they opt to use an exchange or a reputable wallet, their personal details may be required to create their accounts. In that way, Bitcoin transactions don't stay completely anonymous and are subject to scrutiny from the government or law enforcement agencies. Through this, they can perform specific duties like imposing crypto tax protocols or even combat money laundering.

Can Governments Track Bitcoin?

Anyone can trace Bitcoin with the help of a standard blockchain explorer. All crypto transactions are logged and recorded on the blockchain's publicly available ledger, meaning governments and law enforcement agencies can trace Bitcoin transactions if they suspect any illegal act related to these transactions.

For example, the Federal Bureau of Investigation (FBI) and Internal Revenue Service (IRS) can observe the bitcoin transactions of any given wallet address. They may then analyze the addresses and the activities tied to them, leading the authorities to the users’ identities.

Platforms and Agencies Tracking Bitcoin

Several data platforms have offered their services to law enforcement agencies to help track and investigate any suspicious crypto activity. Hacks and scams usually leave behind breadcrumbs often enough to start an investigation. The breadcrumbs eventually lead to identifying a user's wallet by cross-referencing against previous criminal history and KYC details shared by crypto exchanges.

One such platform is Chainalysis. In the first half of 2022, Chainalysis reported a significant drop in crypto-based scams, but the amount of funds stolen by hackers increased, reaching billions of dollars in cryptos.

The Department of Justice (DOJ) also pays close attention to illicit crypto activities. In June 2022, they seized millions of dollars worth of Bitcoin stolen during the Colonial Pipeline ransomware attack in 2021. And on the international scene, the DOJ had partnered with Chainalysis to track close to 30 million dollars worth of cryptos stolen in a North Korean hacking attack.

How Do Tracking Platforms Trace Bitcoin?

Each platform has its process for tracing crypto transactions. In Chainalysis' case, its method for tracing Bitcoin transactions can be summarized into three steps:

1. Clustering
2. Identification
3. Categorization

Clustering

A cluster is a compilation of addresses held by the same singular entity. Various algorithms are run covering the history of the blockchain. Numerous strategies are also employed for a more in-depth data analysis, such as identifying behavioral patterns and masking methods.

Identification

After clustering several addresses, the entity is identified using automated and manual methods.

Categorization

The entity is labeled and tied to the service provided by its level of risk.

Why Should Anyone Bother Tracing Bitcoin?

Bitcoin is widely used for several completely legitimate purposes, in which case you’d like to monitor your transaction’s status and check payments made for each transaction. Some of the legitimate purposes are as follows:

• Making Investments
• Monitoring Savings
• Completing payments
• Sending Remittances

However, tracking blockchain transactions can also be used for a slew of crimes, such as those listed below:

• Scams and Ransomware
• Money Laundering Operations
• Tax Evasion
• Financing Terrorism

Can Authorities See When Crypto is Bought?

Data analysis and collaboration with tracking platforms are only half the story. Private companies aside, the authorities may also request detailed information about a certain address from crypto exchanges and other service providers.

Centralized exchanges, such as Coinbase, managed by a singular entity, must comply with these regulations to acquire and maintain a license to operate in any country. Because of these regulations, the potential customers of these exchanges must submit several documents and provide the required personal details before transacting with the exchange.

These exchanges employ KYC protocol to aid the authorities in verifying the users’ identities and analyzing bitcoin transactions. The protocol aims to reduce anonymity and thwart any opportunity to use cryptos for illegal purposes.

With several money laundering cases linked with crypto service providers, regulations have been put in place which obligate these service providers to disclose information on suspicious bitcoin transactions. Authorities may request a crypto exchange to share and disclose the data that these exchanges have asked for from the users.

Challenges in Tracing Bitcoin Transactions

Preserving anonymity may be challenging, but there are ways to protect your privacy and make it difficult to trace blockchain transactions. Let’s focus on two methods: multiple wallet addresses and bitcoin mixing. Both methods present obstacles that scale the effort and time it takes to pin an address. Individually, these methods are big hurdles to people who’d like to track your bitcoin transactions; when applied together, they can be potent deterrents to tracing bitcoins transactions.

Multiple Wallet Addresses

Crypto wallets themselves can be quite difficult to trace. Should users wish for their activity to be untraceable, they may create several wallets and transactions as a smokescreen to mask their activity.

A single wallet address is more prone to hacking, especially if it has a hefty cryptocurrency, which can easily draw attention. It’d be wiser for the owner to have multiple wallet addresses with a smaller number of crypto coins.

Bitcoin Mixer

Bitcoin mixing is another method that can make tracing your bitcoin transactions challenging. Software and services that perform this method are known as bitcoin mixers, also known as bitcoin tumblers or bitcoin mixing services.

So, what is a bitcoin mixer?

A bitcoin mixer is a cryptocurrency service devoted to preserving users’ privacy. Several mixing/tumbling services exist, each with unique features. However, they share common characteristics.

Common Characteristics of Bitcoin Mixers

Most mixers support the Tor Browser, which conceals a user’s browsing activity, effectively preventing the tracking of these activities. They also charge a mixing fee, which varies depending on the bitcoin mixing service provider, the type of mixer used, and the deposit amount put up by the user.

Several crypto mixers feature time delays, making blockchain analysis burdensome. Some tumblers randomize the delay, but some provide user-controlled delays. Additionally, many coin mixers allow multiple output addresses and charge an additional fee for each additional address. There is no standard maximum number of addresses nor a fee for the supplemental addresses.

Bitcoin Mixing Process

Although bitcoin mixing is a popular choice for protecting a crypto user's privacy, not many understand its process. This section will answer the question, "How does a bitcoin mixer work?”

You need to perform five key steps if you want to participate in a mixing pool.

1. Create a wallet address, ensuring it won’t be linked to you.
2. Go to the bitcoin tumbler's website; check if you have the correct web address.
3. Configure the recipient’s wallet address.
4. Indicate your preferred time delay and desired wallet distribution.
5. Deposit your cryptocurrency to the address specified by the mixer.

The crypto coins you deposited will be shuffled with the coins from other users before they are sent to the specified recipient’s address. Because of the shuffling, the coins can’t be traced back to their respective addresses.

The Legitimacy of Bitcoin Mixers

Government authorities have been cracking down on bitcoin mixers, causing naysayers to predict the death of coin tumblers. The crackdown has also raised the question, “Are bitcoin mixers illegal?

Bitcoin mixers aren’t illegal. But they have been, on occasion, associated with criminal activities, such as money laundering and other illegal operations. These have warranted shutdowns of a few coin mixers by various law enforcement agencies.

But not all coin tumblers are involved in illegal acts. Some money laundering cases happened because criminals took advantage of the privacy that crypto mixers provide.

Regardless, you have to choose a reputable coin tumbler. Do not forget to check out websites that evaluate a coin mixer’s risk—choose one with a high trust score. You must remember that the term best bitcoin mixer is relative. No matter how popular a coin tumbler is, the gauge of a coin mixer’s performance will depend on how well it suits your needs, e.g., speed of service, ease of use, pricing, etc.

Anonymous Wallets

Caution must be taken when using an anonymous wallet. Your identity may inadvertently be revealed, defeating the entire purpose of said wallet. The wallet by itself doesn't guarantee total anonymity. Should any user make multiple crypto transactions, identities may be linked to certain wallets with information tied to them. With stricter KYC protocols, making transactions anonymous has become much more difficult.

There are, however, some wallets that offer complete anonymity. One example of this is the Electrum wallet. This wallet can also work in conjunction with a hardware wallet, further increasing the chances of anonymity. But one should still take caution when opting to use such a wallet. You must consider how you would transfer funds onto it because once crypto is sent to it via an exchange, you lose that anonymity.

Should You Publicly Share Your Bitcoin Address?

Publicly sharing your crypto address is safe, making it much easier for Bitcoin transactions. No one can steal cryptocurrency through a public address unless someone has access to the keys.

There’s a vast difference between private and public keys. Public keys are more similar to a person's email address. It can receive mail from just about anyone, and only its owner may open them. The same concept applies to crypto wallets. You receive funds from anyone, anywhere, and so long as you hold the keys, only you may access them.

On the other hand, private keys act as the password to access the wallet. This unique code must be protected and kept in a secure place offline where only you may access it. Sharing such sensitive information with anyone else jeopardizes the security of the funds.

While your digital assets remain safe despite sharing your bitcoin address publicly, your privacy may not be as safe as you want it to be.

In Summary

Bitcoin transactions are not as private nor as anonymous as everyone believes. Instead, cryptocurrency is pseudonymous, with your bitcoin address as your assumed identity when conducting bitcoin transactions.

Cryptocurrencies function like fiat currency. But unlike fiat currency, cryptocurrencies are not overseen by a single authority. However, they can still be scrutinized because each transaction is logged publicly on the blockchain. The public ledger means anyone can do surface tracing with the help of blockchain explorers.

Moreover, most crypto users will have to reveal their identities at some point. For instance, they may need to provide personal details when creating an account with a crypto exchange or a reputable wallet, preventing them from staying completely anonymous.

Governments and law enforcement agencies may request that crypto service providers provide detailed information about suspicious addresses or bitcoin transactions. These providers are compelled to comply, and along with tracing platforms, the authorities may analyze the addresses and the activities linked to them. The anonymity factor is further reduced with the required implementation of the KYC protocol.

However, there are ways to make bitcoin transactions more difficult to trace. You may use several different wallets or a bitcoin mixer. Both options may not guarantee 100% anonymity and privacy, but they can always discourage scammers from tracing bitcoin transactions.

With multiple bitcoin wallets, you can separate your transactions so that you cannot link them. A user who sends you crypto needs help identifying the other digital wallets you have and the transactions you do with them.

Bitcoin mixers blend your coins with other users before sending them to the intended recipients. Doing so breaks off the transaction's connection from your digital address, ensuring your transactions' privacy. Remember, though, that not all coin blenders are trustworthy.

A coin blender's popularity is not enough assurance of its trustworthiness. The key here is to keep yourself informed. Research thoroughly the bitcoin mixer you intend to use before getting into a transaction.