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In its early years, blockchain earned a strange kind of fame: cryptocurrency became renowned for its supposed anonymity. The Bitcoin network was so securely protected by sophisticated encryption that it could not be hacked even by yet-to-be-built quantum supercomputers.
Money was supposedly untraceable, incorruptible, and invincible thanks to the SHA-256 hash encryption standard. Like so much else in blockchain, this concept of impenetrable anonymity began with bitcoin, but its main points were soon expanded to apply to other cryptocurrencies.
Like a lot of other things in crypto, the truth about anonymity is a little more complicated.
Anonymous and Pseudonymous
An anonymous person can function or communicate in a way that renders them unrecognizable. Someone who uses a pseudonym operates or communicates in a way that allows them to be recognized, yet their identity conceals who they are.
Consider the comments area of a website, where no login is necessary, and people can leave remarks without identifying themselves. This is the definition of anonymity. The Rock, whose actual name is Dwyane Johnson, is an example of pseudonymity, as is any other professional who works under a stage name.
Although many cryptocurrencies, such as bitcoin (BTC), are more traceable than cash transactions, certain cryptocurrencies, such as Zcash (ZEC), Monero (XMR), Grin (GRIN), and Beam (BEAM), were built with anonymity and privacy in mind.
While certain transactions are made anonymous in order to facilitate illegal activity, privacy is a core human right guaranteed to individuals by governments and is a necessary component of greater freedom.
Anonymous transactions, for example, allow people to transfer large sums of money from one point to another without drawing any attention. Many crypto community members are pseudonyms for privacy, either to conceal their identity as part of a push toward self-sovereignty or to protect their own privacy or security. Many people like Bitcoin because pseudonymity is embedded into the protocol.
When you create a bank account, you must provide documentation that connects your financial activities to your identity and is neither anonymous nor pseudonymous. When you establish a Bitcoin wallet, you generate an alphanumeric address that allows you to send and receive bitcoin and is accessible to everyone on the blockchain. However, because financial forensics on your public address may be connected back to your real-world identity, this address provides pseudonymity rather than anonymity.
In general, cryptocurrencies are more pseudonymous than anonymous. A wallet address shows nothing on its own; possession of a private key confirms that you control a wallet. As a result, blockchain transactions are remarkably traceable; evidence from the bitcoin network has even been cited in US courts. The classic aphorism that possession is nine-tenths of the law appears to be true in the context of blockchain. When the public address and private key are combined, blockchain seems to be a pseudonymous system rather than a totally anonymous one.
This is one of the key reasons why bitcoin founder Satoshi Nakamoto has never been definitively identified, as he has never transferred or sold his coins.
However, some blockchain implementations go to great lengths to ensure that their pseudonymity is as near to anonymity as possible. “Obfuscated ledgers” can considerably complicate auditing. Such coins have a practical use and give ideological pleasure to privacy extremists, but they are also occasionally used for money laundering and crime.
A boon for Anti-Money Laundering efforts
Regulators have critiqued the crypto sector on several occasions on the grounds that anonymity in crypto facilitates illicit activities like money laundering. But is that accurate? Not at all. Laundering money using cryptocurrencies is perhaps a really stupid idea since blockchain analytics tools allow law enforcement to track the whereabouts of target funds easily.
This is not just a theory but something that has already been accomplished. Leading cryptocurrency exchange Binance has assisted the law in a multinational police investigation of the cybercrime gang known as Fancycat.
While most addresses are ‘anonymous’, if an address can be linked to a real-world identity, it doesn’t offer complete anonymity. There are a number of ways to connect addresses to real-world identities, typically via KYC & AML policies at exchanges and blockchain analysis.
A fairly recent incident, the recovery of much of the $4.4 million ransom paid by Colonial Pipeline to a Russia-linked hacker group, raised questions as to whether bitcoin is free from government control and manipulation.
What isn’t well-known is that relevant enforcement agencies can track down bitcoin purchases if they are prepared to put in sufficient effort. That’s why one of the worst things someone could do is try to launder illicit money with bitcoin or pseudo-anonymous cryptocurrencies in general. According to experts, the governments can trace crypto transactions with the help of blockchain experts and by serving seizure orders issued by district courts.
It is a myth that bitcoin and other public ledger-based cryptocurrencies are anonymous. However, advances are rapidly being made in cryptocurrency platform development. If you want to transfer and receive cryptocurrency fully anonymously, as well as keep your money in an account with a non-public balance, your best bet is Monero, the most private and secure cryptocurrency as of now. However, some blockchain firms are already devising methods that could trace even privacy-enhanced cryptocurrencies.