Bitcoin Transaction Privacy

There have been many claims that Bitcoin is “anonymous.”  Others call Bitcoin “pseudononymous” because transactions are not linked to an identity.  If a Bitcoin address is linked to an identity then all the transactions can be seen by anyone.  In some cases users want transactions to be public for accountability purposes.  Recent reports have implied that nearly all transactions can be linked back to an owner.  The truth is somewhere in between but it takes a little understanding of how Bitcoin transactions work.

One thing that is often confused in the discussion is the difference between a Bitcoin address and a Bitcoin wallet.  A Bitcoin address is a single address while a wallet is a collection of Bitcoin addresses.  The public Bitcoin database, the “blockchain,” contains the balances of all Bitcoin addresses but has no information about Bitcoin wallets.  A Bitcoin wallet is software that runs on your computer and compiles the balance of all your Bitcoin addresses.  (Note that online wallets may be handled differently and this discussion is for software wallets you run on your computer).

The next thing to understand is how Bitcoin transactions work.  Transactions have “inputs” and “outputs.”   The simple rule is that the total of all the inputs must equal the outputs.  That means if you have 10 Bitcoins in an address and you send 1 Bitcoin to someone there is another transaction that sends 9 Bitcoins back to yourself.  In Bitcoin terminology this is called “change” and the 9 Bitcoins goes to a “change address.”  These “change addresses” are created automatically and many new users don’t realize they exist since your wallet totals the balance of all the addresses

There are 2 main ways anonymity is lost.  The first way is aggregating balance to a single address.  If somewhere along the line one of those addresses was linked to your identity they are now all linked together due to the aggregation.  The first step here is to never purposely aggregate the funds.  Many are of the belief that aggregation is somehow necessary .  There is no reason to do that because the wallet program adds up the balances for you.

The second problem is unintentional mixing of addresses.  The standard Bitcoin client (Bitcoin-QT) does not have tools that allows users to easily control which address in the wallet are used to send funds.  Since most users don’t realize all these addresses exist in their wallet unintentional mixing can occur.

To avoid this problem a wallet such as Bitcoin Armory can be used which has many advanced features.  One feature is that multiple wallets can be used to completely segregate funds.  That way you can have wallets with addresses linked to your identity while maintaining other wallets not linked to your identity and they never mix.  Another feature of Bitcoin Armory is “Coin Control.”  This feature allows you to control which address is used to send funds so you can prevent mixing.

The Anatomy of a Bitcoin Wallet video shows these features in Bitcoin Armory.

Note how a donation address on a web page (see below) can link a payment to an identity and transactions after the donation may be traced.  Future tipping and wallet proposals use systems where a new Bitcoin address is created each time a donation is made for both accounting and privacy purposes.




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