While bitcoin is often referred to as an anonymous online currency that is used by criminals on the dark web, the reality is that the P2P digital cash system does not offer much privacy to its users at all. Many blockchain analytics companies have popped up over the years, and these observers are able to track the flow of funds on Bitcoin’s public accounting ledger.
Bitcoin’s privacy issues are so severe that alternative cryptocurrencies, such as Monero and Zcash, have gained recognition due to their ability to offer better privacy to users.
Many ideas for better privacy in Bitcoin have been floated over the years, but none of them have been implemented into the core protocol or gained widespread use. However, the way in which enhanced privacy could potentially come to Bitcoin has become clearer over time.
Bitcoin’s Privacy Issues
The key issue with Bitcoin privacy is that all transactions are published on the blockchain. While the identities on the blockchain are pseudonymous, it does not take too much effort to track the flow of funds once real names are attached to Bitcoin addresses at exchanges or other similar hubs of activity.
The most well-known privacy tool in Bitcoin today is CoinJoin, which allows multiple users to come together and mix their bitcoins with each other in a single transaction. The idea is that someone looking at the blockchain can see where the money went into the transaction but cannot tell which Bitcoin address received the funds.
This sounds like a powerful tool at first, but there are two key issues with CoinJoin.
For one, the values involved in these mixing transactions are public, which means anonymity is lost if everyone is mixing different amounts. If Bob is mixing one bitcoin, it’s easy to see where his coins ended up if everyone else is not also mixing one bitcoin. All an observer would have to do is look for the one bitcoin output that resulted from the CoinJoin transaction.