Bitcoin's Pseudonymous Nature And The Cost of Blockchain Surveillance

Most blockchain networks like Bitcoin (BTC and BCH) are not presenting direct anonymity features.

All transactions are recorded permanently on a transparent and public distributed ledger. Moreover, all transactions are connected with hashes, and the route of the funds is traceable. Transparency is a feature of the Bitcoin blockchain and not a weakness, though.

Interestingly, Bitcoin in the past was advertised as anonymous digital cash and used massively in the dark web, especially with the rise of the online black markets.

This anonymity veil dropped probably right after the Silk Road arrests when Bitcoin experts explained to the mainstream that Bitcoin wasn't genuinely an anonymous digital currency as the news was often claiming until that point.

However, until recently, the evidence against those persecuted, especially in popular cases that reached the mainstream (Silk Road, MtGox), did not contain blockchain transactions, and limited blockchain analysis was performed to track down and arrest those accused.

The tracking of transactions is not an easy or cheap process either. Certainly, agencies would prefer a more centralized approach to reduce surveillance costs.

Delaying On-Chain Adoption Enhances Surveillance

While the complex system of not reusing Bitcoin addresses provides a sense of pseudo-anonymity, it didn’t take long before programmers created analytic tools connecting addresses and linking transactions to identities.

Eventually, KYC was established slowly within all crypto exchanges, and almost every transaction can link to an identity.

Although, even before KYC was forced, a cryptocurrency trader was withdrawing money from exchanges into banks, where KYC was mandatory already.

The subsequent problem is fake KYC in bank accounts and crypto exchanges. Criminals manipulated the banking networks for decades and wouldn't stop with crypto exchanges. Fake IDs do not present a new concept, and even a video conference will not hinder criminals.

The purpose of KYC enforcement is not about the reduction of criminal activities though, but to constantly survey transactions and control the funds' flow.

KYC is a Threat rather than a Security Mechanism

Is any observer able to track a transaction to a real name?

We probably learned that online anonymity and privacy are not easy to achieve, and Bitcoin (BCH & BTC) transactions are not anonymous but transparent and permanently recorded instead.

Is it easy and inexpensive to track transactions?

Blockchain analytics software exists and combined with leaked databases containing KYC lists, presents a danger to cryptocurrency owners.

Major exchanges and various cryptocurrency services have suffered leaks of databases containing private information such as names, addresses, funds, and accounts connected. This data is traded in black markets of the dark web for years and has reached the hands of criminal networks.

Researchers with access to analytics software and KYC databases can track transactions directly to a real name.

It is mostly used for criminal purposes, perhaps to extort users to hand over funds. 

Private data leaks present a security issue for all cryptocurrency holders. Which percentage of the hundreds of millions of cryptocurrency owners are criminals anyway?

Obviously less than 1%. Yet the leaks of KYC databases to the dark web, create issues to the 100% of cryptocurrency owners.

Every major leak of KYC databases in the past has created massive waves of extortion and phising email attempts. Examples of crypto database leaks:

• Trezor (recent)

• KeepChange (Feb 2021)

• Coinmarketcap (Oct 2021)

• BuyUCoin - India (Jan 2021)

• Ledger (July 2020)

• Kraken (April 2020)

• Digitex Futures (Feb 2020)

Moreover, there could be leaks we haven't heard of or never reached the news. These hacks do not target exchanges, but the cryptocurrency owners directly.

It turns out that KYC is not a procedure that safeguards investors assets, and reduces corruption or criminal activities, but it certainly becomes a threat to the investors and users of cryptocurrencies.

As with the credit/debit card banking sector, most databases of cryptocurrency exchanges have been leaked and sold to the black market.

Manually Tracking Transactions Is Not An Easy Task

Bitcoin (BTC and BCH) transactions are pseudonymous, but the system is not easy when manually trying to connect wallets and transactions.

After the MtGox collapse in 2014 and the announcement of 800,000BTC stolen by hackers, Bitcoin investors lost millions in this exchange.

Some of the BTC investors formed a group and tried to manually track the transactions of the hacked BTC, but the mass databases they collected required special analytics software. Manually, it was impossible to perform analysis and reach definite conclusions.

Even blockchain analytic companies such as Chainalysis wouldn't bother to scan addresses and track funds unless they are hired by a government, agency, or private company for this reason.

And it becomes more difficult to track transactions, when obfuscating mechanisms are used. Some of these mechanisms create anonymity features for Bitcoin, however, even these transactions are under the spectrum of investigation with agencies working together with blockchain analysis teams to find clues linking obfuscated transactions with the owners.

Some OGs achieve complete anonymity, but surveillance technology advances.

It takes advanced skills to achieve anonymity, and even so, one simple mistake could be enough.

Most of those arrested so far for Bitcoin-related "crimes" were not caught by blockchain analysis but simple mistakes they did, irrelevant to their cryptocurrency transactions.

Ross Ulbricht (Silk Road) and Alexander Vinnik left hints of their real identity online. The agencies did not track the transactions to their names until way later.

However, in the recent years, blockchain analytics advanced to provide proof even when obfuscating mechanisms are used:

Crypto researchers and coders were building out more sophisticated tracking tools, hoping to bring some order and accountability to a space rife with scamming and bad actors.

TRM Labs, for example, developed a tool to combat the effectiveness of “chain-hopping,” a set of actions in which launderers move funds rapidly across different blockchains (like converting Bitcoin to Ethereum to Solana).

Elliptic, similarly, developed automated tracing techniques to track money across “peeling chains,” in which cryptocurrency is routed through a bevy of addresses.

-Source: Inside the Chess Match That Led the Feds to $3.6 Billion in Stolen Bitcoin

It is not cheap or easy to perform blockchain analysis.

Blockchain analysis requires access to exchange KYC databases and tools.

An agency with the help of blockchain analytics probably can track most transactions but won't bother looking when there is no "criminal" activity involved since the cost would be unbearable.

There is another approach here, though.

The cost of on-chain surveillance as transactions are increasing

The cost of surveillance would be extremely high even with all the software advancements and the compliance of centralized exchanges.

Those early in Bitcoin probably remember the adoption progress until about 2015, when everything stalled according to Bitcoin Core wishes. Lightning Network was the scaling solution supported by the Blockstream-led coalition of devs, promised to be released within 18 months. Tehse 18 months turned into seven years, as BTC altered the narrative into store of value.

The way the blocksize debate is presented makes every newcomer think that Bitcoin Cash was an attack on the Bitcoin network, yet in fact, Bitcoin Cash was the most popular option.

The plan appears to proceed with regulating BTC, crippling it to avoid too many transactions and reducing the extensive cost for agencies to track down every transaction on the network.

Instead of blockchain transactions, use an easier approach, a second layer only operable within centralized hubs and constantly tracking transactions under regulatory guidelines.

As with the financial banking networks, transactions will be constantly under surveillance, with regulated financial institutions bearing most of the cost of this operation.

And this is how Lightning Network re-creates the legacy payment networks, as centralized hubs become critical for Lightining to be functional.

I can't tell if Lightning will become mainstream or not, but I can definitely tell if the Lightning Network becomes mainstream, it will be centralized.

LN seems to be the final strategy imposed to delay the inevitable transition from fiat into sound decentralized P2P cash.

In Conclusion

(source)

Online anonymity is not only a concern that concerns criminals. This is a low percentage of the cryptocurrency field reflecting real-life statistics.

Yet, governments use "criminal" behaviors to undermine blockchain networks and increase surveillance.

It is not easy or cheap for any random observer to track transactions.

Modern analytic tools are not readily available, and to link transactions to a real identity, KYC databases are required.

Still, KYC becomes a threat instead of a step to enhance security since multiple databases with names, emails, and addresses have been leaked to black markets and reached the hands of criminals.

Bitcoin (BTC & BCH) presents a case of pseudonymity, and tools such as mixers and tumblers enhance the privacy of transactions.

The cost of blockchain analysis is too high, though, and not available to a random observer. It takes skills to analyze the databases and reach a definite conclusion.

Is pseudonymity better or worse than the future the Central Banks have in store for us with the upcoming release of CBDCs and the totalitarian control of finance?

• Cover Photo: by " sebastiaan stam" on Unsplash (modified)

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