Can Bitcoin be traced?
Absolutely. In fact, Bitcoin only functions because every transaction is traceable in the ledger called the blockchain.
If I send Bitcoins from my (simplified) address 1AA to my friend’s address 1BB, that transaction is forever recorded. Now, when my friend attempts to send bitcoins from his address 1BB to a store’s address 1CC, the store’s computer can look and see that indeed, address 1BB contains bitcoins, because they were sent to him in my transaction from address 1AA. Even though these addresses are generated randomly and a person isn’t immediately tied to an address, as soon as an address can be linked to a person or entity, a long rabbit-trail of transactions could potentially unravel a large part of that entity’s activity.
Another reduction of anonymity is found in the way Bitcoin clients typically combine outputs from previous transactions to make a new transaction.
For example, say that it is known that address 1AA is linked to me. But I also have address 1QQ and 1ZZ that I have never shared with anyone. Address 1AA has 2 bitcoins, address 1QQ has 3, and address 1ZZ has 5. Now say I want to send 9 bitcoins to a friend. My client will automatically combine the bitcoins from all three addresses into a single transaction. This makes public the fact that the owner of all three addresses is the same person. Anyone who knew that address 1AA was linked to me now also knows that 1QQ and 1ZZ is also linked to me.
Note that this is rather painstaking analysis to do by hand, but there exist some tools that can accomplish the same purpose and show which addresses are related to each other with ease.
Now, if you’re looking to obscure your Bitcoin activity, you might check out a project called DarkWallet. Though it is still in alpha testing, it provides several solutions for the lack of anonymity and privacy in the world of Bitcoin.
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