First of all, it is useful to draw a basic distinction between anonymity and privacy in the context of financial transactions. We will call a transaction “anonymous” if no one knows who you are. We will call a transaction “private” if what you purchased, and for what amount, are unknown.
Let’s analyze a simple example and locate different kinds of financial transactions within it.
Cash or barter are the most intrinsically private and anonymous means of transacting.
Bitcoin is anonymous, but not private: identities are nowhere recorded in the Bitcoin protocol itself, but every transaction performed with Bitcoin is visible on the distributed electronic public ledger known as the blockchain.
The anonymity provided by Bitcoin is at once a point of attraction and a challenge for financial regulation. As the pace of adoption of the currency grows and as it comes under scrutiny by the legal and financial systems, particularly with regard to compliance with applicable anti-money laundering (AML) statutes and know-your-customer (KYC) controls, its true level of anonymity will become an increasingly closely studied subject.
For many users of Bitcoin, who access the currency through one of the popular online wallet or exchange services, their participation at the outset entails linking their personal identity to their Bitcoin holdings. Bitcoin for these users is effectively no more anonymous than a bank account, although this loss of anonymity takes place at the point of entry into the currency and is not a feature of the Bitcoin protocol itself.
For those who wish to take advantage of Bitcoin’s intrinsic anonymity, they must find an alternative entry point, such as acquiring Bitcoin in a private transaction, as compensation for goods or services rendered, or as a reward for mining. Subsequent Bitcoin transactions can then be anonymous, since real-world identities are not recorded on the blockchain ledger: the only identifying information recorded there are the Bitcoin addresses, whose corresponding private keys are held by the owners as proof of ownership.
Maintaining one’s anonymity from this point forward, however, is in no way guaranteed: even supposing one manages to acquire Bitcoins without giving up personal information, one’s real-world identity can still be discovered in the course of transacting Bitcoin within the network. Let’s look at how this can happen.
Broadly speaking, deanonymization techniques pursue one of two complementary approaches, having to do with the public nature of the transaction ledger and with the possibility of exposing the IP addresses of the computers originating the transactions.