How to Protect Your Privacy When Using Bitcoin?

The inherent right to privacy has risen to prominence as one of the most critical human rights of our generation. Privacy is about being able to control the information that you share with other people. It safeguards us against power abuses and exploitation. The right to privacy is expressly stated in Article 12 of the Universal Declaration of Human Rights and is recognized by human rights laws worldwide. Whereas privacy is not specifically recognized in the Laws of several nations, including the United States, Ireland and India courts have established that right in other provisions.

Nevertheless, privacy remains subjective. Governments and institutions continue to buy and sell personal data to identify us and infer facts about us. Yet, there is hope for privacy-conscious Bitcoin users. With proper understanding of its supporting and underpinning technologies, one can indeed send, receive and hodl bitcoin privately!

In this post, we’ll look at what privacy means in the Bitcoin scope and how to protect it.

Index

Bitcoin Privacy Explained
   Pseudonymous Ownership
  How pseudonyms safeguard your identity
  Transparency demands safeguarding

Bitcoin Privacy Enhancements
  The 2017 SegWit paved the way for the 2021 Taproot Privacy Upgrades
  Taproot Explained
  Lightning Network Privacy Enhancements

Bitcoin Privacy Concerns
  Many online wallets are easy to identify
  Your IP address may be linked to all your Bitcoin addresses
  Your third party apps, websites, or web browsers may disclose your identity

Bitcoin Privacy Solutions
  Bitcoin full node privacy
  Utilize Multiple Signatures (MultiSig)
  Utilize multiple addresses
  Utilize Coin Control

Bitcoin Privacy Tools: BItcoin Mixers, Tumblers, and Blenders.
  Tumblebit
  CoinSwap
  CoinJoin
  Alternative Strategies

Conclusion

Bitcoin Privacy Explained

Bitcoin’s privacy and anonymity is much different than in traditional banking. While Bitcoin transactions are more anonymous than a bank statement, there is no impenetrable barrier keeping your identity private forever, as some believe.

While Bitcoin can support strong privacy, many ways of using it are usually not very private.  In fact, Bitcoin transactions are not private at all. After all, they are all recorded to a public blockchain for anyone to see, at any time. However, Bitcoin addresses are pseudonymous. This means that while every transaction can be linked to a specific address, that address does not have to be linked to your identity. 

Peer-to-peer transactions involving bitcoin do not require the use of a middleman, bank, or third-party. Instead, cryptography is used to secure and validate ownership and transactions in blockchain technology. Due to this symbiotic balance between privacy and anonymity, individuals can transact with one another, directly, regardless of whether they know or trust one another. 

Pseudonymous Ownership

One of the most misunderstood benefits of bitcoin’s blockchain is its pseudo-anonymity. This is because the terms “anonymous” and “privacy” have traditionally been used interchangeably, but not in the crypto world. The distinction is especially important when dealing with bitcoin transactions. For example, your transaction is only “anonymous” if it is not linked to your personal identity. In contrast, it is only “private” if the transaction details can be accessed by the parties involved.

The term “privacy” is best described as the degree to which you have control over who can access your information. By its very nature, the blockchain ledger counteracts the traditional concept of privacy. The ledger is publicly distributed data of transactions between two or more pseudo-anonymous parties. Pseudonymity enables Bitcoin users to maintain privacy while ensuring the ability to audit the full supply of bitcoin.

Bitcoin’s transparent properties enable you to audit your business down to the smallest satoshi (Bitcoin’s smallest unit) without disclosing your true identity or location. The decentralization of finance, has removed the need to rely on a central entity to verify and store transactions privately, as it is with traditional banking. Instead, the validity of a transaction is verified by a randomly selected machine with network access.  Once a transaction has been established and cryptographically confirmed by other network users or nodes, a block of data is added to the distributed ledger. A block stores the minimum bits of data necessary — timestamp, public keys, and transaction amounts.

When you purchase Bitcoin, all you need to do is provide your public key, which will direct the sender’s bitcoins to the correct address. As a result, the sender’s only piece of information required to initiate a bitcoin transaction is the receiving party’s public key. 

In any case, there is no requirement that the parties on either end be identified. This essentially encapsulates the bitcoin protocol’s pseudonymous property.  However, complete privacy is somewhat compromised as a result of bitcoin’s transparency. 

How pseudonyms safeguard your identity

In the crypto world, your privacy is only as strong as the most-revealing link to your pseudo-identity. Once addresses are utilized, they get polluted by the history of all the transactions with which they are associated. Anyone may view the balance and history of all the transactions related to any address. Due to the permanent nature of the Blockchain, it’s critical to keep in mind that anything that is untraceable today may become easy to track in the future. 

With Bitcoin, your privacy is enhanced by the use of pseudonymous accounts. Transactions are made up of inputs and outputs and are uniquely identified by transaction IDs. From a high-level perspective, the following is revealed about each transaction:

• The approximate date and time of the transaction’s mining (from the block header).
• The addresses and quantities to which bitcoins were transmitted (i.e. the “transaction outputs”).
• The source of the transaction’s finances (i.e. the inputs).

Everyone in the Bitcoin ecosystem has access to each account’s balance history, but they do not have access to the identity of who owns the account. In contrast, consider how conventional banks, credit unions, and governments, handle privacy. They (attempt to) keep your bank balance secret. This puts them in a precarious situation since they are the only ones with comprehensive supervision of what is occurring.

Transparency demands safeguarding

In Bitcoin, transparency is achieved most simply by establishing a link between two identities via encrypted digital signatures. Bitcoin enables unprecedented transparency, enabling you to audit your business anonymously and without disclosing your name or location. For obvious reasons, someone with substantial Bitcoin wealth is unlikely to want to advertise their holdings to everyone they meet.  As a result, Bitcoin users must maintain a certain degree of anonymity. 

While the exact method varies depending on the wallet software used, the fundamental concept is always the same. You create a verbal proclamation and digitally sign it with your private key. This does not prove the truth of the assertion; rather, it establishes that the transaction was initiated by the address owner. 

Bitcoin Privacy Enhancements

The 2017 SegWit paved the way for the 2021 Taproot Privacy Upgrades.

Segregated Witness was a 2017 Bitcoin upgrade that made performing advanced scripting updates to the Bitcoin codebase significantly easier. The upgrade improved Bitcoin users’ transaction privacy by enabling future updates such as the addition of Schnorr Signatures and support for sidechains.

Schnorr signatures are a method of signing bitcoin transactions that was recently added to Taproot as part of an upgrade. Unlike ECDSA signatures, Schnorr signatures allow for the consolidation of multiple signatures into a single one, enhancing privacy and making multisignature and smart contract transactions more accessible and affordable. They not only improve transaction privacy, but also facilitate scaling by reducing the size of multi-signature transactions.

Taproot Explained

Taproot is a 2021 upgrade to the Bitcoin Core codebase with the goal of improving transaction privacy while reducing the amount of data required to complete sophisticated sidechain transactions, resulting in significant fee reductions. Additionally, the privacy benefit will be extended to apps that make use of time-locked contracts, such as CoinSwap, which combines Bitcoin transactions to obscure the origin and destination of the transaction. 

Similar to this is how the Lightning Network, a second-layer network for aggregating off-chain transactions, operates. Taproot will encrypt these applications. Taproot combines Schnorr signatures with Merkelized Abstract Syntax Trees (MAST) — a technique for concealing a smart contract’s unexecuted branches. It enhances privacy and scalability by removing data from the blockchain.

Taproot enhances the privacy of transactions on sidechain protocols such as the Lightning Network, CoinSwap, multisignature, and smart contracts by making them appear identical to standard single-signature on-chain transactions.

Lightning Network Privacy Enhancements

Lightning Network is an off-chain transaction solution. Its security approach is almost identical to that of on-chain bitcoin transactions.

• Lightning transactions are not recorded on a publicly accessible ledger.
• Lightning transactions employ onion routing.
• Lightning transactions do not allow for the mixing of inputs and cannot be clustered.

Lightning Network transactions are also quicker (usually immediate) and cheaper than on-chain transactions. Two-way payment channels are formed between lightning nodes, and lightning transactions are routed between them. The source and destination nodes do not have to be connected directly via a payment channel, as transactions can be routed via a number of intermediary nodes.

Because Lightning Network transactions take place off-chain, they are not broadcasted to all network nodes and are not permanently kept in a publicly accessible blockchain. Adversaries are unable to get a permanent public record of all transactions due to the absence of such a record. Adversaries may instead have to run intermediary nodes to extract any information.

To protect the confidentiality of intermediate routing notes, the Lightning protocol takes use of onion routing. The technique is meant to prevent intermediate nodes along a payment route from finding whether additional nodes, other than their predecessor or successor, are included in the packet’s route.It also conceals the length of the route and the node’s position within it.

Bitcoin Privacy Concerns

Many online wallets are easy to identify.

HD (Hierarchical Deterministic) wallets can generate multiple addresses while requiring only a single backup seed to retrieve the funds. Additionally, these wallets will generate a new address for you each time you receive a transaction.

Bitcoin wallets are conceptually distinct and leave distinct imprints on the blockchain, much like how browsers reveal information about themselves while browsing the web. As a result, specific transactions can occasionally be attributed to a particular type of Bitcoin wallet program. If your adversary is aware of the wallet application you’re using, he or she can associate your identity with one of your transactions, eroding your privacy. Each piece of information helps an adversary grasp who you are and what you do. 

Due to the requirement that each transaction must have a source of funds, they become connected, forming what is known as a transaction graph. If you pay a friend in bitcoin, you will be able to see not only the inputs you used, but also the dates and addresses to which the coins were spent. Your IP address is almost certainly linked to each of your Bitcoin addresses. Additionally, there are numerous ways for you to be associated with a transaction even if you did not transact with a known entity, as Bitcoin transactions are typically sent in unencrypted packets over the Internet and the source IP address of the transaction can be determined in a variety of ways.

Geolocation IP databases frequently use your IP address to estimate your physical location. More importantly, your IP address identifies your Internet Service Provider (ISP), which in turn knows the owner’s true identity and is frequently required by law to retain it for several months.

Bitcoin transactions sent via full nodes such as Bitcoin Core require some triangulation or targeted traffic sniffing to determine the source IP address, whereas transactions sent via “light” wallets such as mobile wallets are frequently broadcasted directly to company-run servers that can view your IP address and transaction history. 

Even if you are using a public WiFi network to conduct your transactions, the websites you visit and background services your device connects to may incorrectly associate your true identity with that IP address. When your laptop boots, the Dropbox application connects happily to Dropbox’s corporate servers, which log your IP address as being associated with your Dropbox account. Similarly, when you navigate to a personal account on any website, the same thing occurs.

Your third party apps, websites, or web browsers may disclose your identity.

When a transaction on the Bitcoin network is completed, two distinct types of traces are left behind. These are classified as “what is on the blockchain” and “what is not on the blockchain.” While blockchain data does not directly link your identity to your transactions, it does reveal information that can be used to do so. The second category of items, “what is not on the blockchain,” does create a link between your identity and your transactions.

The worst-case scenario for privacy is when you use a third-party service as your Bitcoin wallet that requires KYC, as these services will keep track of all your transactions and your real-world identity. Even if you do not visit any personal websites, cookies stored on your laptop can reveal your identity to websites you visit because the cookie is associated with your previous browsing history. Numerous websites permit this type of third-party user tracking for analytics purposes.

You could be connected to a Bitcoin address or transaction simply by conducting a web search using web-based tools, as there aren’t that many people searching for your transactions on the web for no reason other than your own.

Even if you delete your cookies, website operators can still track your activity across multiple websites as long as your browser fingerprint is unique, allowing them to link your IP address to your identity. Additionally, even if you disable all services and avoid browsing entirely, the network provider may obtain your device’s MAC address, which can be used to link it to your identity via complex methods. Thus, even if your IP address cannot be linked to you via your ISP’s records, you may leave additional traces when using your personal devices.

TOR hidden services are currently the best option for concealing your source device and IP address when requesting or transmitting transaction information. Numerous wallets, including Bitcoin Core, enable this feature through configuration, while others include it by default. TOR may also be advantageous for your web-based Bitcoin activities, as it masks your IP address, clears cookies on exit, blocks third-party cookies and is immune to the majority of browser fingerprinting techniques.

Bitcoin Privacy Solutions

Regrettably, there are hundreds of possible connections between a Bitcoin transaction and the true identity of an individual. True pseudonymity is exceedingly difficult to obtain against a cunning adversary. Any genuine attempt at Bitcoin anonymity necessitates the use of robust encryption and communication protocols.

Bitcoin full node privacy

Downloading the entire blockchain is the most secure method of operating a wallet. Due to the fact that all other lightweight solutions rely on third-party servers, they all disclose which addresses are yours. The Electrum servers will be able to determine which addresses are yours and link them together. Despite bloom filtering, SPV nodes provide significantly less privacy than nodes connecting directly to the wallet.

In some instances, such privacy may not be required. However, one of the most compelling reasons to run a full node and use it as a wallet is to maximize privacy. Clients running on a full node replicate the transactions of all users in the same way they replicate their own. This means that tracing the origins of a particular transaction may be challenging, as any Bitcoin node could be mistaken for the transaction’s originator.

A critical first step is to configure your node to run exclusively on TOR. The majority, if not all, home node implementations, such as Raspiblitz or Umbrel, will configure your node in this manner. To begin, it is easier to configure and eliminates the need for port forwarding, which is inconvenient for the vast majority of users. If you must use an IP node, consider concealing your home or server IP with an always-on, anonymous, static IP VPN.

Utilize Multiple Signatures (MultiSig)

Additionally, you can protect your cryptocurrency by creating a multi-signature address (multi-sig). This tool requires crypto holders to enter multiple private keys in order to authorize a transaction. To generate a multisign address, at least two public keys are required. Additionally, a key signer will be required for each public key that you require. For instance, if you wish to use a multi-signature system that requires approval from at least three of five individuals, you will require five public keys. With this tool, a criminal will be unable to tamper with your accounts. Even if he only has one private key in his possession, he will be prompted to enter the additional keys.

Utilize multiple addresses

Bitcoin operates independently of the conventional banking system as a financial system. Bitcoin enables you to hold money without relying on a third party and places the responsibility squarely on you to keep those assets secure and accessible. While opening a bank or other financial institution requires time and money, setting up a Bitcoin account on your home computer is simple and quick. This simple procedure enables you to create an unlimited number of distinct accounts.

Create a unique Bitcoin address for each payment you receive to safeguard your privacy. Additionally, a variety of wallets are available for a variety of purposes. This enables you to decouple individual transactions. Individuals who send you money have no idea that you have additional Bitcoin addresses or what you do with them. Without a doubt, this is the most critical piece of advice to remember.

Bitcoin Privacy Tools: Mixers, Tumblers and Blenders

This is an established method for severing the transaction graph. Additionally, “tumblers” or “washers” are used to refer to them. A user sends bitcoins to a mixing service, which in exchange for a fee sends the user different bitcoins. Theoretically, a party observing the blockchain would be unable to connect incoming and outgoing transactions.

Tumblebit

TumbleBit is a 2016 anonymous payment protocol that is backwards compatible with the current state of the Bitcoin protocol. TumbleBit allows parties to conduct transactions through an untrusted tumbler. Nobody knows who paid who during the TumbleBit epoch, not even the Tumbler. This is accomplished via a cryptographic mechanism in which the server facilitates the exchange of private digital signatures. 

Anyone interested in privacy or bitcoin will find the protocol extremely interesting. Because hundreds of users can perform this concurrently, transaction anonymity is maintained, as a large number of transactions (> 500) can be settled on the blockchain using only two transactions.

CoinSwap

CoinSwap is a non-custodial privacy technique for bitcoin based on the concept of atomic swaps. CoinSwaps may appear to be identical to any other blockchain transaction. They make it possible for bitcoins to teleport undetectably to any other address on the blockchain. Non-CoinSwap transactions would benefit, as a large-scale blockchain analyst, such as one employed by a transaction surveillance company, can never be certain that ordinary transactions are not CoinSwaps. Additionally, they occupy a small amount of block space relative to the amount of privacy they provide.

CoinSwaps necessitate a high degree of interaction between the parties involved, which can make designing this type of system challenging while avoiding denial-of-service attacks. Additionally, they have aliveness and non-censorship requirements, which means that the entities participating must always have unrestricted access to the bitcoin network; if the internet goes down for days or weeks, half-completed CoinSwaps may result in the theft of one party’s funds.

CoinJoin

CoinJoin is a simple protocol that enables strangers to pool their transactions. As the transaction will contain the inputs and outputs of multiple users, this helps conceal the destination address to which a single user sends data. Coinjoin transactions are a subset of bitcoin transactions in which multiple individuals or entities collaborate to create a single transaction that incorporates all of their inputs. It accomplishes this by violating the heuristic of common input ownership and utilizing bitcoin’s inherent fungibility within transactions. 

This technique has been possible since the inception of bitcoin and cannot be blocked except in the same way that any other bitcoin transaction can be blocked. By looking at a transaction, it is impossible to determine for certain whether it is a coinjoin or not. CoinJoins are non-custodial in nature, as they can be conducted without one party stealing another party’s bitcoins.

Alternative Strategies

Mixers, tumblers and blender-type software services should be last resort options as they come with a plethora of disadvantages. The mixer’s confidentiality of the connection between incoming and outgoing transactions must be guaranteed. Additionally, one must rely on the mixer not to steal coins. 

There is a superior manual alternative to mixers that shares the same concerns about privacy and custody as mixers. A user can deposit and then withdraw coins from any traditional bitcoin website that accepts hot wallets. As long as the bitcoin service does not require additional information from the user, it offers the same level of privacy and custody as a centralized mixer at a much lower cost. Suitable bitcoin services include bitcoin casinos, bitcoin poker websites, tipping websites and online marketplaces.

Conclusion

Numerous previously mentioned privacy technologies conceal sensitive information by adding additional data to the bitcoin blockchain. This unintended consequence reduces Bitcoin’s scalability by increasing the amount of data the system must process. This compromises privacy by increasing the cost of running full nodes, the most private method for a user to discover their history and balance. 

Off-chain transactions provide a way around the trade-off between privacy and scalability. These types of solutions improve privacy by obliterating data from the blockchain entirely, rather than by adding additional dummy data. Enhancements to script privacy also contribute to the system’s cost savings while increasing privacy.