Despite what many believe, Bitcoin is not truly anonymous – instead, it is pseudo-anonymous. This is one of its most important qualities, though, due to giving both transparency and anonymity to those who utilize it, while giving the ability to prove your identity and ownership at the same time.
Transparency of Transactions
Every single transaction that occurs through Bitcoin is logged into the blockchain. You never actually store your bitcoins, nor do you actually trade them. What you do is akin to signing over a deed to a house – you’re simply logging the change of ownership. The blockchain, therefore, simply tells who owns the coins and who they were transferred to. The last owner then has access to them and can do with them as they please.
Because everything is logged in the blockchain, that also makes it fully transparent. Anyone, including you, I, or the government, can see everything that is happening at any point in time. Once coins have been minted (through mining), we can track it from its creation to its last holder. So it begs the question of why this is such a great thing. It ensures that all coins are accounted for at all times. No money can magically go missing – you can track anything and everything you want. If coins magically somehow came out of nowhere, it would be blatantly obvious, which helps ensure that the hard cap of 21 million coins stays in effect. Along with this, you can also easily prove your identity by signing your address or adding a public memo to an outgoing transaction – both of which you can let others see without risking your coins.
Why is it Considered Pseudo-Anonymous?
In cryptocurrencies, like Bitcoin, your identity is essentially tied to your wallet, which is made up of many addresses you hold private keys to. But there is no personal information tied to any of this. For example, if I wanted to purchase your car for $50k and BTC is currently $1k, I could sign a message from an address of mine that holds 50 BTC, which proves to you that I hold and control the 50 BTC. And nobody can dispute this, as you have proof right there on the blockchain that I am telling the truth.
This is also where the “pseudo” part comes in. We make the trade, and my information is still not attached to the blockchain in any way. However, you have it, and you can then put an identity on the address I sent coins from. From that point on, we have that sort of attachment, which allows you to identify me if I were to do anything questionable. And this is an attachment that happens on every purchase that occurs, whether from a store, giving coins to an exchange, or buying and selling coins. It doesn’t mean that everyone is able to track you down personally, but following enough links and going from one person to another can help find an identity, should someone leak their information in this manner.
Because everything you do on the blockchain can be seen, there are a couple of things you can do to help prevent information leakage. First off is to simply not buy anything that requires someone to know your name and address. Things like web hosting are a great example, as well as many other services. The second is to use multiple Bitcoin addresses. The general rule is to use a separate address for every input you receive. So if I sent you 0.1 BTC, you would want to give me a new address. If I was going to send more, you would want to use another one. This lets you separate your identity through obfuscation, such that you aren’t giving a large number of people the same link to follow you through. It is worth noting, however, that any time you do business with someone that knows who you are, there are small trails created – nothing is perfect, and many cases in the past have shown that deep heuristics on the blockchain can yield a lot of information.