Bitcoin: Not So Private After All?

How private are financial transactions that use the "virtual currency" Bitcoin? According to Timothy Lee, writing at Forbes, not very:

Bitcoin's peer-to-peer method for clearing payments means that the currency's "books" are inherently open. Every transaction ever made using the currency is available for inspection using a tool like Bitcoin's Block Explorer. 

The privacy benefits come from the fact that you can create an unlimited number of anonymous Bitcoin identities. Block explorer tells me that someone sent 36953.2525 Bitcoins to the address 148X4kTYZhjeKQcd1AVhcytXvh5gL6FNSe. I don't know who owns that address and there's no central database where I can look it up. Nor is there a Bitcoin Inc. that could be compelled to create such a database. And this, Bitcoin enthusiasts say, give their currency a privacy edge over the US dollar.

But the fact that the database doesn't exist doesn't mean it couldn't be created. Remember, people want money so they can buy stuff. There are a few goods and services, like pornography or consulting work, that can be delivered entirely over the Internet. But people mostly buy products that need to be physically delivered. An American who wants to deal primarily in Bitcoins will, at some point, need to either buy food and shelter in Bitcoins or convert some of their Bitcoins to dollars. And that means making Bitcoin payments to people in the US.

But the US government could easily require any business accepting Bitcoin payments (or converting Bitcoins to dollars) to collect identification information from their customers in the same way that "know your customer" regulations require financial institutions to collect information about their customers. And once the government has de-anonymized a significant fraction of the addresses on the network, they'll be able to infer many of the others using basic detective work.

Lee suggests that a sufficiently determined individual could use Bitcoin in a way that mostly preserved his or her anonymity, but only with significant technical savvy and lifestyle changes. This tracks with what one Bitcoin developer told Reason's Katherine Mangu-Ward last month: "With bitcoin, every transaction is written to a globally public log, and the lineage of each coin is fully traceable from transaction to transaction….Attempting major illicit transactions with bitcoin, given existing statistical analysis techniques deployed in the field by law enforcement, is pretty damned dumb." Naturally, Sen. Chuck Schumer is worried about illegal purchases using Bitcoin anyway. 

In June, Reason.tv talked with Mercatus Institute scholar Jerry Brito about Bitcoin: