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Is Cryptocurrency Anonymous?

How blockchains and cryptocurrencies handle investor data is a topic of great interest in the market. The data-encryption layer of a blockchain is one of the mechanisms that attract traders the most.

However, there is an essential difference between encrypting users’ data and providing transaction anonymity. How can a system guaranteeing perfect traceability of transactions achieve excellent privacy protection?

This article introduces and explores the topic of crypto anonymity with some practical, real-life examples.

The original Bitcoin idea

Before better understanding the current composition of the blockchain market, let’s start with the mother of all cryptocurrencies. When the famous Bitcoin whitepaper appeared online, few understood the exact concept introduced by Satoshi Nakamoto.

Today, in retrospect, many notions of the document indeed appear more transparent. Nevertheless, we believe observing what Nakamoto proposed in section “10. Privacy “of the whitepaper is helpful.

The author presented a critical limit on the level of privacy of the traditional banking system. As a counter-proposal, Nakamoto designed a system that removed all third parties and counterparties.

Today everyone can reconstruct Bitcoin flows worldwide, an aspect unthinkable for a traditional bank. Transactions go through a data-encryption process, which assigns pseudonyms to each operation.

However, creating a pseudonym is not sufficient to protect users’ privacy. What if someone managed to associate the alias with the person or company that holds BTC?

If this operation appears impossible, it is good to clarify the concept of “block explorer“. A block explorer is a tool used to find information about a blockchain. For example, these providers usually know each user’s IP address.

The issue is evident since the IP address provides information on a user’s geolocation connected to the internet. Therefore, no transaction in BTC is truly anonymous: it is only hard to trace the users’ real identities.

For this reason, experts never associate the idea of anonymity with BTC. However, more technically, we can talk about pseudonymity.

Did Satoshi Nakamoto think about anonymity?

If we continue reading the Bitcoin whitepaper, we will realize a peculiar aspect. Nakamoto never mentioned in the text the idea of making a perfectly anonymous instrument.

On the contrary, his original idea was to build a more transparent payment system. Nakamoto’s only proposal on privacy never found a great application among mainstream cryptocurrencies.

Specifically, Nakamoto recommended introducing an “additional firewall”, as he put it, into the system. In addition, the founder of BTC proposed using different keys and addresses for each transaction.

Anyone would have to buy and sell BTC using wallets with different addresses to translate this idea into practical terms. Furthermore, no wallet would have had more than one transaction, making it genuinely impossible to link a pseudonym to its owner.

In this context, it is no coincidence that “Satoshi Nakamoto” himself is, in reality, only a pseudonym.

The predominance of pseudonymity

Most of the cryptocurrencies we find in circulation are pseudonymous coins. In other words, it is straightforward to know the alias connected to each transaction, but it isn’t easy to obtain more information.

Historical cryptocurrencies such as BTC or ETH belong to this category and are more recent coins. The choice of pseudonymity is also a matter of pure practicality for a token creator.

Let’s think, for example, of traders who use centralized exchanges (CEX) to operate on the market. The regulator asks each CEX to have specific customer data in many countries.

We are talking, in particular, of the so-called Know-Your-Customer (KYC) procedures. Therefore, linking a crypto wallet to a customer’s name is not complicated once you have this information.

Those who want to list a token on a CEX must give up a fundamental level of privacy for traders.

The introduction of privacy coins

There is a category, a minority on the market nowadays, aiming to ensure greater anonymity of transactions. We are talking about “privacy coins”, or tokens that obscure operations on the blockchain.

In this system, only those involved in the transaction know its amount and counterparties. The level of anonymity of privacy coins concerns external observers.

However, the more anonymous nature of these coins can also attract criminal activity. For this reason, the debate about the actual social utility of these tools is still open.

To date, Zcash and Monero are two famous cases of privacy coins. Monero is one of the few cryptocurrencies that uses Nakamoto’s temporary addresses (or “stealth addresses”) to enhance its anonymity.

Furthermore, Monero introduces an additional level of data encryption on the signature of a transaction. Since 2017, this cryptocurrency has also made it possible to hide a single transaction amount.

Zcash, on the other hand, provides the user with the freedom of choice in the execution of a transaction. If traders wish to hide their identities, they can use the blockchain’s zero-knowledge mechanism.

Final thoughts

This article has explored the topic of anonymity in the world of cryptocurrencies. The original idea of the Bitcoin founder is clear: to remove trusted third parties from the system. His original whitepaper mentions privacy but doesn’t put the subject at the core of the blockchain.

For this reason, the fact that BTC is not a genuinely anonymous cryptocurrency does not appear shocking. However, pseudonymity remains a highly prevalent feature in the industry, and it will be interesting to see how the situation evolves in the future.

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Privacy coins guarantee more excellent protection of anonymity on a blockchain. However, we still need to understand whether these tokens are socially sustainable from a regulatory point of view.

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