Answering One of Blockchain’s Biggest Questions: Anonymity or Pseudonymity?

In its first few years, blockchain achieved a paradoxical sort of renown: Cryptocurrency became famous for its perceived anonymity. Bitcoin, the argument went, was so thoroughly secured by advanced cryptography, that even yet-to-be-built quantum supercomputers could not hack it. Money protected by the SHA-256 hash encryption standard was untraceable, incorruptible, and unbeatable. Like so much else in blockchain, this belief in impregnable anonymity began with bitcoin, but its general points were extended to apply to other cryptocurrencies. Like so much else in crypto, however, the reality of anonymity is a little more complicated.

The encryption on bitcoin remains unbreakable, quantum computing remains in the distant future, and there are no ways to recover accidentally lost or intentionally destroyed private keys. To draw a parallel with analog security, the world’s most complicated safe can, with patience, tools, and expertise, be cracked, but a lost bitcoin is unrecoverable. Because coins can be lost as utterly as if they’d fallen into a black hole, users understand that cryptocurrencies are a sort of black box. Blockchain is, after all, a distributed ledger technology, and an essential element of its value is that blockchain transactions are, for lack of a better term, transparent. With bitcoin, for example, we know where each and every bitcoin ever mined currently resides: All the information is present on the blockchain. Even “lost” bitcoins can be located; they’re lost because their private keys have disappeared, not because the coins themselves vanished.

What does this combination of transparency and security mean for cryptocurrency’s relation to anonymity? In short, it means that cryptocurrencies are generally more pseudonymous than anonymous. A wallet address on its own proves nothing; possession of a private key proves that you control a wallet. As such, transactions on the blockchain are surprisingly trackable; evidence from the bitcoin blockchain has even been used in U.S. courts. The old adage that possession is nine-tenths of the law apparently holds in a blockchain context. Once the public address and private key are united, blockchain suddenly appears to be a pseudonymous system, not a fully anonymous one. The fact that bitcoin creator Satoshi Nakamoto has not moved or sold his coins is, in fact, one of the primary reasons that he has never been conclusively identified.

There are, of course, some blockchain implementations that take extra measures to make their pseudonymity more closely resemble anonymity. “Obfuscated ledgers” can make auditing significantly more difficult. Such coins have practical uses and provide a certain ideological satisfaction for privacy radicals, but they’re sometimes used for money laundering and crime: Too often the public perceives them as the heirs of the seediness and criminality that the broader blockchain community has abandoned long ago.

As governments and regulatory bodies scrutinize blockchain, both anti-money-laundering (AML) and know-your-customer (KYC) regulations have become much more familiar to blockchain proponents. Many in the industry are concerned that AML and KYC requirements might detract from blockchain’s traditional strengths and that they might curtail the technology’s ability to assist the unbanked or non-traditional investors.

These are legitimate concerns — it’s frustrating to learn, for example, that certain tokens are geographically restricted or limited to SEC-approved accredited investors — but the advent of KYC and AML is not so radical an upheaval as it might appear. What very little is lost in privacy terms warrants ample compensation: KYC and AML ensure that blockchain and its various implementations are safer and more reputable. They also preserve blockchain projects from legal enforcement and remove much of the uncertainty that has hindered certain large-scale blockchain implementations. Some projects seek the best of both worlds: They aim to create products that comply with KYC and AML without storing identifying information.

Blockchain continues to develop: Every day, new uses are suggested, new rules are promulgated, new coins are mined, and new investors make their first outlays. It’s unlikely that debates on security, privacy, and autonomy will end anytime soon, either in blockchain or in the broader tech world. As these arguments continue, we should remember that anonymity is not an end in itself. Rather, blockchain exists to improve the world and its informational systems. An overemphasis on one feature of the technology runs the risk of compromising its greatest potential.

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