Early promises of cryptocurrency transaction privacy…<\/strong><\/p>\r\n\r\n\r\n\r\n Bitcoin, launched in 2009, was a new kind of money.<\/p>\r\n\r\n\r\n\r\n Like cash, and unlike financial assets that are tied to a particular identity<\/a>, bitcoin can be passed from hand to hand without the need for any third party to approve transactions.But bitcoin also promised to add a huge leap in efficiency compared to traditional currencies.<\/p>\r\n\r\n\r\n\r\n \u201cFor as long as we\u2019ve been tinkering with computers, there\u2019s been a dream of digital cash\u2014something that would be non-traceable, anonymous, instant, free to use and that would interoperate with computer networks,\u201d says Lana Swartz<\/a>, an assistant professor at the University of Virginia.<\/p>\r\n\r\n\r\n\r\n Bitcoin\u2019s pseudonymous inventor, Satoshi Nakamoto, played up the privacy benefits of the currency in the white paper<\/a> he or she published at launch.<\/p>\r\n\r\n\r\n\r\n \u201cPrivacy can be maintained by keeping public keys anonymous,\u201d wrote Nakamoto.<\/p>\r\n\r\n\r\n\r\n A bitcoin public key is generated, through an irreversible mathematical operation, from the private key that confers ownership of the cryptocurrency<\/a>. The private key\u2014as its name suggests\u2014must be kept secret to prevent theft of the associated coins.<\/p>\r\n\r\n\r\n\r\n While bitcoin\u2019s transaction record\u2014its blockchain\u2014is open to scrutiny by anyone, no one will be able to work backwards from a blockchain entry to the identity of the person initiating a transaction, Nakamoto argued.<\/p>\r\n\r\n\r\n\r\n \u201cThe public can see that someone is sending an amount to someone else, but without information linking the transaction to anyone,\u201d he\/she said.<\/p>\r\n\r\n\r\n\r\n A further security step\u2014using a new \u2018address\u2019 for each bitcoin transaction\u2014adds another privacy safeguard, Nakamoto noted in the white paper.<\/p>\r\n\r\n\r\n\r\n A bitcoin address is generated from each owner\u2019s public key via another irreversible mathematical function.<\/p>\r\n\r\n\r\n\r\n From private key to bitcoin address\u2014two encryption steps<\/em><\/p>\r\n\r\n\r\n\r\n Source: Mastering bitcoin, Andreas Antonopoulos<\/em><\/p>\r\n\r\n\r\n\r\n \u2026proved dangerous to some<\/strong><\/p>\r\n\r\n\r\n\r\n Some early bitcoin users took the cryptocurrency\u2019s apparent promise of anonymity at face value in the most provocative way: they used the new payments medium to trade in drugs and other illicit goods.<\/p>\r\n\r\n\r\n\r\n \u201cBitcoin,\u201d wrote\u00a0the<\/em> Guardian <\/em>in 2013<\/a>, \u201cand Silk Road [the main online drugs marketplace] are closely linked.\u201d<\/p>\r\n\r\n\r\n\r\n \u201cThe Silk Road site, which enables users to anonymously order drugs, guns, and more, only takes payments in the digital currency,\u201d said the UK newspaper.\u00a0<\/p>\r\n\r\n\r\n\r\n Silk Road and other darknet markets accounted for 30 percent of transactions in bitcoin in 2012, according to one estimate<\/a>.<\/p>\r\n\r\n\r\n\r\n But preventing law enforcement agencies from linking cryptocurrency transactions in dark web markets to real identities has proved much harder than expected.<\/p>\r\n\r\n\r\n\r\n Ross Ulbricht, the founder of Silk Road, left online traces<\/a> that allowed US federal agents to uncover his identity. Ulbricht was convicted in 2015 of money laundering, computer hacking and conspiracy to traffic narcotics, and is currently serving a life sentence.<\/p>\r\n\r\n\r\n\r\n \u201cYou\u2019re only as private as your weakest point,\u201d says Matt Odell, a cryptocurrency analyst.<\/p>\r\n\r\n\r\n\r\n \u201cYou can do everything perfectly, but if you get one thing wrong, that\u2019s what compromises you.\u201d<\/p>\r\n\r\n\r\n\r\n In fact, any attempt to ensure complete anonymity in this digital age may be a pipedream. Jameson Lopp, chief technology officer at cryptocurrency custodian Casa, recently described<\/a> the complex and exhaustive steps needed to achieve what he calls \u2018modest privacy protection\u2019.<\/p>\r\n\r\n\r\n\r\n \u201cI had to fill out hundreds of pages of paperwork, spend around $30,000 in legal, banking and service fees, and endure a four-month process in order to achieve my goals. I estimate annual recurring costs of over $15,000 for my extreme setup,\u201d Lopp wrote.<\/p>\r\n\r\n\r\n\r\n \u201cFundamentally, the \u2018crypto\u2019 in cryptocurrency is not privacy: it\u2019s security and authentication,\u201d Lopp told New Money Review<\/em>.<\/p>\r\n\r\n\r\n\r\n Linking cryptocurrency addresses to identities<\/strong><\/p>\r\n\r\n\r\n\r\n Most of the work of linking past cryptocurrency transactions to individual identities is performed by specialist blockchain analysis companies such as Chainalysis, Elliptic and Coinfirm.<\/p>\r\n\r\n\r\n\r\n A recent report suggested<\/a> that spending by government agencies and regulators on such forensic blockchain analysis\u2014equivalent to mapping the DNA of individual cryptocurrency networks\u2014has tripled in the last year.<\/p>\r\n\r\n\r\n\r\n \u201cFor-profit companies are surveilling the network and trying to deanonymise every transaction they can,\u201d says Jameson Lopp.<\/p>\r\n\r\n\r\n\r\n Cryptocurrency exchanges, particularly those offering \u2018on-\u2019 and \u2018off-ramps\u2019\u2014converting cryptocurrencies from and to fiat money\u2014are another key client segment for the blockchain analysis firms.<\/p>\r\n\r\n\r\n\r\n \u201cBlockchain monitoring software is an essential part of our toolkit,\u201d Obi Nwosu, chief executive at London-based cryptocurrency exchange Coinfloor, told New Money Review<\/em>.<\/p>\r\n\r\n\r\n\r\n \u201cWe need to have policies and procedures around anti-money-laundering and countering terrorist financing. On the fiat currency side there are long-standing ways of doing this, like sanctions lists. Blockchain monitoring tools provide the equivalent on the cryptocurrency side,\u201d said Nwosu.<\/p>\r\n\r\n\r\n\r\n Jonathan Levin, chief executive at Chainalysis, told New Money Review <\/em>how clients such as exchanges and wallet providers make use of his firm\u2019s analyses.<\/p>\r\n\r\n\r\n\r\n \u201cThey are assessing the risk of their counterparty, looking for source of funds and whether a customer received money from illicit sources,\u201d said Levin.\u00a0<\/p>\r\n\r\n\r\n\r\n \u201cOur customers have become more sophisticated in detecting patterns of transactions and customizing risk scores per jurisdiction,\u201d he added.<\/p>\r\n\r\n\r\n\r\n \u201cBlockchain analysis companies make a determination about a particular cryptocurrency address that is always percentage-based,\u201d says Coinfloor\u2019s Obi Nwosu.<\/p>\r\n\r\n\r\n\r\n \u201cWe take in various bits of information on both the fiat currency and cryptocurrency side and derive an internal scoring metric. If we receive a score on the blockchain side that\u2019s above a certain level we can label it as a certain level of risk,\u201d said Nwosu.<\/p>\r\n\r\n\r\n\r\n \u201cWe can also get guidance from blockchain monitoring companies based on what other exchanges do. They work with various government agencies as well, which also informs their advice.\u201d<\/p>\r\n\r\n\r\n\r\n However, Nwosu declined to go into detail about how his exchange makes use of the analyses it receives from firms like Chainalysis.<\/p>\r\n\r\n\r\n\r\n \u201cWe can\u2019t disclose details of how we apply this information as we don\u2019t want to tip off criminals,\u201d he told New Money Review.<\/em><\/p>\r\n\r\n\r\n\r\n Discounts on \u2018tainted\u2019 coins<\/strong><\/p>\r\n\r\n\r\n\r\n Efforts to divide blockchains into \u2018clean\u2019 and \u2018tainted\u2019 transaction histories have had an effect on cryptocurrencies\u2019 secondary market prices.<\/p>\r\n\r\n\r\n\r\n Speaking at the recent MJAC\/Cryptocompare conference in London, Benjamin Dives, chief executive of the London Block Exchange (LBX), explained how his exchange had recently received a request to sell 8,494 bitcoin (worth around US$3m) via a block trade.<\/p>\r\n\r\n\r\n\r\n The bitcoin to be sold came from three source addresses, said Dives, one of which proved to be clean. However, the other two could be traced back to a transaction that had involved the Silk Road market, said Dives, who illustrated the provenance of the coins with a chart.<\/p>\r\n\r\n\r\n\r\n Tainted bitcoins from the Silk Road<\/em><\/p>\r\n\r\n\r\n\r\n Source: London Block Exchange<\/em><\/p>\r\n\r\n\r\n\r\n Reflecting the doubtful origin of the coins, the seller offered a discount of up to 5% of the market price for bitcoin, according to LBX, which declined the trade.<\/p>\r\n\r\n\r\n\r\n \u201cSomeone can try to clean coins by going on a walk through 15-20 other wallets. But the technology allows us to see that,\u201d said Dives.<\/p>\r\n\r\n\r\n\r\n However, he added, the US government\u2019s stance on cryptocurrencies has been ambiguous.<\/p>\r\n\r\n\r\n\r\n \u201cWhat does clean tainted bitcoin is the FBI. They did this when they auctioned off the Silk Road wallets. If the US government had such a strong stance against bitcoin they could have destroyed the coins.\u201d<\/p>\r\n\r\n\r\n\r\n In 2014\/15, the US Justice Department auctioned off the 144,336 bitcoins it seized from Silk Road for an average of $334 each.<\/p>\r\n\r\n\r\n\r\n Marian Muller, a compliance consultant working with cryptocurrency exchanges, told New Money Review<\/em> that it should not be up to exchanges to take a view on the transaction history of a particular coin.<\/p>\r\n\r\n\r\n\r\n \u201cHow far back we should go [in cryptocurrencies\u2019 transaction histories] will probably be up to the regulators,\u201d said Muller.<\/p>\r\n\r\n\r\n\r\n \u201cBut for us as exchanges, I would argue it should only be checking the actual depositing addresses. For example, banks only check the identity of the person depositing cash. They don\u2019t somehow trace the cash back three steps to see if it was used to buy drugs a week ago by someone else.\u201d<\/p>\r\n\r\n\r\n\r\n \u201cThis becomes a philosophical question very quickly\u2014is one \u00a310 note worth less than another because of how it was used previously? Should it be? It’s hard to answer a question of how much screening we should be doing without exploring those fundamental questions of what money is,\u201d Muller said.<\/p>\r\n\r\n\r\n\r\n A taintchain<\/strong><\/p>\r\n\r\n\r\n\r\n Others suggest making different use of the ability of forensic tools to trace digital currency transactions far back into the past.<\/p>\r\n\r\n\r\n\r\n \u201cEfficient coin tracing may damage the fungibility of bitcoin,\u201d said Ross Anderson, Ilia Shumailov and Mansoor Ahmed of Cambridge University in a paper published earlier this year<\/a> entitled \u2018Making bitcoin legal\u2019.<\/p>\r\n\r\n\r\n\r\n Fungibility means that the individual units of a currency or commodity are interchangeable: in other words, an individual dollar, pound or euro is taken by the currencies\u2019 users as identical to any other.<\/p>\r\n\r\n\r\n\r\n Rather than using a percentage-based \u2018haircut\u2019 or \u2018taint\u2019 score for individual cryptocurrency addresses, Anderson, Shumailov and Ahmed propose the introduction of a new methodology to provide more accurate tracing of stolen or illicitly earned coins: a \u2018first-in, first-out\u2019 (FIFO) accounting system, where withdrawals from an account are deemed to be drawn against the deposits first made to it.<\/p>\r\n\r\n\r\n\r\n \u201cOverall, most bitcoin accounts have zero taint using FIFO, while less than 24% escape taint if we use a haircut approach,\u201d say Anderson, Shumailov and Ahmed.<\/p>\r\n\r\n\r\n\r\n The academics propose the introduction of open-access public \u2018taintchains\u2019, calculated using the FIFO methodology, to make stolen or illicitly earned coins visible to all.<\/p>\r\n\r\n\r\n\r\n They also suggest that cryptocurrencies purchased from regulated exchanges should be regarded as taint-free, but that exchanges should also be required to keep reserves proportional to their trading activities in order to reimburse clients should coins sold as clean turn out to be tainted.<\/p>\r\n\r\n\r\n\r\n The greatest privacy battles lie ahead<\/strong><\/p>\r\n\r\n\r\n\r\n However, the ongoing crackdown on cryptocurrency exchanges and the\u00a0 increasingly intrusive and apparently successful probing by governments and regulators into blockchains may give a misleading impression of the success of law enforcement agencies.<\/p>\r\n\r\n\r\n\r\n Instead, several developments suggest that the major battles over digital money and privacy still lie ahead of us.<\/p>\r\n\r\n\r\n\r\n First, there is the accelerating disappearance of cash as a means of payment, a trend that is chipping away at the last truly anonymous form of money.<\/p>\r\n\r\n\r\n\r\n The likely issuance of government-issued digital fiat currencies will almost certainly pose similar questions about coin provenance as we have seen in cryptocurrencies.<\/p>\r\n\r\n\r\n\r\n Concerns amongst the general public about revealing the details of all their economic activity to the government and tax authorities may well provide a new boost for non-state-controlled media of exchange.<\/p>\r\n\r\n\r\n\r\n Second, however successful bitcoin transaction analysis has been, the introduction of privacy-focused cryptocurrencies poses new technological challenges for those seeking to monitor economic activity through blockchains.<\/p>\r\n\r\n\r\n\r\n \u201cOver the years, the percentage of people using cryptocurrency networks for illicit activity and trying to protect themselves against law enforcement has fallen,\u201d says Casa\u2019s Jameson Lopp.<\/p>\r\n\r\n\r\n\r\n \u201cHowever, those that do use them for such purposes are sophisticated and on the cutting edge\u2014they would prefer to use a Monero or Zcash rather than bitcoin.\u201d<\/p>\r\n\r\n\r\n\r\n Last week, Coinbase, the US cryptocurrency exchange, announced<\/a> that it would henceforth allow its users to buy, sell and store Zcash, although it would not allow users to send the cryptocurrency to so-called shielded (anonymous) addresses.<\/p>\r\n\r\n\r\n\r\n\r\n
\u201cPrivacy can be maintained by keeping public keys anonymous\u201d<\/p>\r\n<\/blockquote>\r\n\r\n\r\n\r\n![\"\"](\"https:\/\/beta.newmoneyreview.com\/wp-content\/uploads\/2018\/12\/private-key-public-key-address-1024x249.png\")
<\/figure>\r\n\r\n\r\n\r\n\r\n
\u201cIf you get one thing wrong, that\u2019s what compromises you.\u201d<\/p>\r\n<\/blockquote>\r\n\r\n\r\n\r\n\r\n
\u201cFor-profit companies are trying to deanonymise every transaction they can.\u201d<\/p>\r\n<\/blockquote>\r\n\r\n\r\n\r\n\r\n
\u201cWe don’t want to tip off criminals.\u201d<\/p>\r\n<\/blockquote>\r\n\r\n\r\n\r\n![\"\"](\"https:\/\/beta.newmoneyreview.com\/wp-content\/uploads\/2018\/12\/silk-road-coins.jpg\")
<\/figure>\r\n\r\n\r\n\r\n\r\n
“Is one \u00a310 note worth less than another because of how it was used previously?”<\/p>\r\n<\/blockquote>\r\n\r\n\r\n\r\n