What is Bitcoin anonymity?

In Bitcoin, anonymity refers to the user's transaction's unlinkability, pseudonymity, and privacy. Unlinkability means an attacker can not link the transactions and different addresses of the user. In blockchain, we require this to hide the user's real identity from the network. However, Bitcoin transactions are not entirely anonymous. If the sender uses the same address to make more than one transaction, the attacker can identify the patterns by linking the transactions and finding the person because all the transactions are public.

For this, bitcoin uses the below-mentioned techniques to keep the anonymity of the blockchain and break the traceability in the blockchain.

Now let us discuss these techniques and their limitations in detail.

Using TOR

The Onion Router (TOR) is a decentralized network used to enhance the privacy and anonymity of the transaction. Mainly, it is used for encrypted online communication, which is achieved with the help of volunteer-operated servers called relays. By leveraging the use of the TOR network in the Bitcoin transaction mechanism, users can hide their location and IP addresses from the third party tracking their services.

When a sender wants to perform a transaction, they will connect with TOR, a gateway for all internet traffic. The data packets pass through TOR relays, and the encryption is decrypted at each layer to know the next hop in TOR. The final layer is the exit relay, which forwards the data to the receiver.

In this way, the TOR helps improve the privacy and anonymity of the Bitcoin network.

Limitation

It is important to remember that only TOR does not provide anonymity in the network. Other factors such as transaction patterns, address reuse, and external can be used to de-anonymize the users. Therefore, to have complete anonymity in the system, we should use other techniques, such as mixing transactions.

Using mixing services

Mixing services, also known as tumblers or mixers, provides a mechanism to enhance anonymity in the Bitcoin transactions procedure. We mainly use these services to break the link between the transaction's sender and receiver. How can it be possible to make a transaction by breaking the link? To understand this, let us discuss the working of mixers.

A user sends the crypto coins to mixers by specifying the recipient's address. The mixing service collects the funds from multiple users and makes a pool of them. It then redistributes the coins to the users from different sources. Simply, the recipient is not directly linked to the original deposit breaking the traceability between the sender and receiver.

The diagram illustrated below shows how the mixing of transactions is done and how every receiver receives the coin with a different address.

Limitation

Mixing services breaks traceability, but mixing services has several limitations. Many mixing services are centralized; users have to trust them that they will misuse their funds. Sometimes it is a time delay process due to the requirement for enough input for a successful mixing. They charge fees as well.

CoinJoin

In CoinJoin, we create a transaction with multiple inputs and outputs that are from different users. It creates ambiguity in determining which input corresponds to which output.

The users who want to participate in CoinJoin first agree on a single transaction. Each user will send the same amount of cryptocurrency in a joint transaction. The amount is collected, mixed in a transaction, and sent to the recipient. It creates difficulty in analyzing which participant sends the transaction to which output address.

The diagram shows the working of CoinJoin.

Limitation

There are several limitations and considerations of using CoinJoin. Anonymity can be compromised if fewer participants are in the CoinJoin process. It will only be applicable if the amount transacted by all the users is the same. The success of CoinJoin depends on simultaneous transactions. Significant timing differences can reduce the privacy and anonymity of the transaction in Bitcoin.

Conclusion

A decentralized system such as a blockchain must require anonymity for security purposes so that hackers cannot identify the patterns and traceability of the transaction. However, making blockchain anonymous is a significant disadvantage because we cannot trace money laundering.

Solve the quiz to understand Bitcoin anonymity better.