In the early days, it was commonly thought that cryptocurrencies like Bitcoin were a safe haven for criminals because they were untraceable and entirely anonymous.
However, as organisations and the public gained a better understanding of blockchain technology, it became apparent that Bitcoin’s public transaction ledger was, in-fact, a gold mine of information for authorities. But the question still remains, how anonymous is cryptocurrency?
What is Cryptocurrency?
A cryptocurrency is a digital or virtual currency which is used as a medium of exchange. It is similar to real-world currency but for the fact it does not have any physical embodiment and uses cryptography, which makes it nearly impossible to counterfeit or double-spend.
When you open a traditional bank account, the bank takes record of your KYC data. However, it is not mandatory to use a KYC cryptocurrency exchange to trade. In fact, a number of exchanges legally operate in jurisdictions that do not mandate KYC, placing them in a grey area in terms of legal obligations. This essentially means there is nothing to stop one user opening hundreds of ‘addresses’ and use them to transfer money between accounts without encountering any red flags, which is a reason cryptocurrencies have quickly become a preferred method of money laundering for criminals as we explored in a recent blog post.
The paradox of cryptocurrency is that its associated data creates a trail that can suddenly make your entire financial history public information. Every single transaction that takes place in Bitcoin is accessible to anyone who is on the network. The addresses which money is sent to and from, the date & time and value of each transaction is all tracked, the only thing which isn’t is the identities of the people behind those addresses.
Bitcoin was the first blockchain-based cryptocurrency and remains the most popular and most valuable. Today, there are thousands of alternate cryptocurrencies with various functions and specifications.
How anonymous is it?
On the one hand, cryptocurrency is entirely anonymous. On the other, it is completely transparent and trackable.
It is anonymous in the sense that you can hold a crypto address without revealing anything about your identity in that address. One person could hold multiple addresses, and in theory, there would be nothing to link those addresses together, or to indicate that the person owned them.
Sending and receiving virtual currency is like writing under a pseudonym. If an author’s pseudonym is ever linked to their identity, everything they ever wrote under that pseudonym will be linked to them.
In the original Bitcoin whitepaper, it was actually recommended that users use a new address for each transaction, to avoid them being linked to a common owner.
“As an additional firewall, a new (address) should be used for each transaction to keep them from being linked to a common owner… The risk is that if the owner of a (address) is revealed, linking could reveal other transactions that belonged to the same owner.”Satoshi Nakamoto, Bitcoin Inventor
What does this mean?
Thanks to the way the algorithm is structured, everything that happens in the Bitcoin world is trackable.
This leads to a level of transparency that may surprise some users; if a Bitcoin address was published on someone’s website for example, everyone in the world would be able to find that person’s balance.
In Bitcoin, your pseudonym is the address to which you receive currency. As every transaction involving that address is stored in the blockchain, if your address is ever linked to your identity, every transaction will be linked to you.
Because all transactions are permanent and public, a massive map is being created as time goes on that allows analytical tools to paint a picture of where bitcoins are going. Bitcoin addresses are ‘anonymous’, but if an address can be linked to a real-world identity, Bitcoin offers no privacy. There are a number of ways to connect addresses to real-world identities, typically via KYC & AML policies at exchanges and blockchain analysis.
‘Unlinkability’ has to be achieved for complete anonymity. However, recent studies show that real-life identities can be linked to addresses of these cryptocurrencies and transactions which use them. Therefore, it is safe to say that most cryptocurrencies are pseudonymous rather than anonymous.
How we can help
One thing you can count on in the world of crypto compliance and regulation is how unpredictable it is. Anti-money laundering regulations are changing all the time and businesses dealing in crypto assets must be prepared to move swiftly, adopt new standards, and protect their business from regulatory scrutiny.
Criminal activity can be headed off at the pass with tools that match customer data with bitcoin transaction histories. This can make it easy to identify high-risk customers, remain AML compliant, and avoid the taint associated with crypto money laundering.
Here at Hello Soda, we provide a range of solutions and specialise in cryptocurrency KYC checks. We offer global verification that takes seconds and all of our solutions are available via our single API, Sodium.
Utilise a single element or multiple processes – it’s entirely up to you. Learn more about how we can help to automate and simplify your verification processes to help you to learn more about your customers.
Download our Cryptocurrency Use Case here to see how we can help improve your processes.