Why privacy is important for Bitcoin users and the challenges it faces

"Privacy is necessary for an open society in the electronic age," states A Cypherpunk's Manifesto. This quote was prominently displayed on a door at the Bitcoin (BTC)-focused Baltic Honeybadger conference in Riga, Latvia, last weekend. Behind that door, in a room aptly named "Cypherpunk," attendees were strictly forbidden from taking photographs or recording.

This stage served as the epicenter for extensive discussions on the importance of privacy for Bitcoin users, an important theme at this annual conference that brings together some of the most influential figures in the global Bitcoin community.

But why is privacy so crucial? Shouldn't society applaud the efforts of corporations to amass user data, governments expanding financial surveillance, and central banks developing CBDC (central bank digital currency) initiatives, which, as acknowledged by a senior central banker, would grant them "absolute control?" Well, it appears that privacy is valued not only by Bitcoin enthusiasts.

Below are the findings of a survey conducted last spring by YouGov, commissioned by the blockchain powerhouse ConsenSys, involving more than 15,000 respondents from 15 different countries.

Source: ConsenSys

The significance of financial privacy

Why is Bitcoin relevant in this context? Bitcoin operates on a public ledger that's open for anyone to analyze. It allows users to trace the movements of the blockchain's native asset, BTC, and potentially link it to a specific individual or company, along with knowledge of their BTC holdings. Consequently, despite the common misconception that Bitcoin provides anonymity, it is, in fact, pseudonymous, which means that the identities of its users can be uncovered, as demonstrated by numerous law enforcement operations leading to the apprehension of suspected criminals.

In the wrong hands, this capability can be misused, both at a personal level, where criminals may target their victims, and at the governmental and corporate levels, making it crucial to consider these aspects as well.

Furthermore, within the blockchain industry, the technology that underpins Bitcoin, numerous companies offer blockchain analysis services to corporations and governments, aiding in the tracking of Bitcoin and other blockchain users. According to Janine, a privacy researcher and investigative journalist who spoke at the Baltic Honeybadger conference (last name undisclosed), this presents significant risks because blockchain analysis has not yet achieved the status of indisputable evidence. Even crypto giant Coinbase, which also provides blockchain analysis services, acknowledged this in 2022 when it published a blog post stating, "Blockchain analytics is more of an art than science." Additionally, ongoing court cases cast doubt on the accuracy of blockchain analysis data as it pertains to the accusations made against individuals, such as in the case of United States v. Roman Sterlingov.

At the state level, there are other concerning indicators as well. For instance, during the conference this past weekend, Rikki, a Bitcoin podcaster and traveler from the Bitcoin Explorers duo, contended that in El Salvador, where BTC holds legal tender status, there appears to be an effort to financially incentivize citizens to use the government-controlled Chivo wallet, thereby aiding the government in monitoring how individuals utilize their BTC.

With all of this considered, what steps are being taken to assist BTC users in enhancing their privacy?

Coinjoins and their challenges

In Riga, a dedicated panel delved into the topic of coinjoin, one of the techniques that contribute to enhancing Bitcoin's privacy. Put simply, a coinjoin is a transaction that combines BTC from various users and pays it back in a manner that makes it nearly impossible to determine the owners of those BTC.

Coinjoins are already incorporated into BTC wallets and services such as Wasabi, Samourai, and Joinmarket. Additionally, this year, coinjoins have been made available on two models of the Trezor hardware wallet.

Nonetheless, this service still requires further refinement and expansion to provide more robust privacy protection.

For instance, Max Hillebrand, the CEO of Wasabi Wallet, emphasized the need to expand the user base of coinjoins for a more effective product. The greater the number of coinjoin users, the harder it becomes to trace their transactions. Furthermore, the issue of centralization requires resolution. Wasabi is currently regarded as a centralized service in how it processes coinjoins, a choice made for the sake of convenience. Hillebrand says it's only a matter of time before this service becomes more decentralized, as it necessitates further research to eliminate potential attack vectors. Meanwhile, cryptographer Fadi Barbàra, another speaker at the conference, is developing a decentralized Bitcoin mixer called DMix, which could serve as another tool to enhance the privacy of BTC users.

Looking ahead, Barbàra expressed his hope that coinjoin technology will evolve to the point where it's impossible to discern coinjoin-related transactions. However, the CEO of Wasabi anticipates the continued existence of identifiable coinjoins, with all user-related data and associated information (such as the device used) removed.

Privacy across the entire Bitcoin ecosystem

In either case, the panel participants largely concurred that, at the protocol level, no significant privacy-related upgrades are required for Bitcoin. Developers simply need to enhance the existing solutions.

However, developers are also actively engaged in various other aspects of the Bitcoin ecosystem that could enhance user privacy. For instance, while conducting BTC transactions through the Lightning Network – a Bitcoin scaling solution – offers added privacy, it is not completely foolproof. Additionally, there are ongoing developments in other protocols and novel concepts, like RGB, which describes itself as a "post-blockchain smart contract" solution and would require a separate article to fully explain.

Moreover, privacy is a necessity in other facets of the Bitcoin ecosystem, with one critical area being nodes. Bitcoin nodes play a pivotal role in the Bitcoin network, alongside miners. They are essential for validating BTC transactions and bolstering the sovereignty of node operators, who play a pivotal role in enforcing network rules.

Hence, developers are working on a solution aimed at heightening the privacy of node operators. This involves encrypting data traffic between nodes and concealing metadata, such as location, making it more challenging for third parties like governments to track nodes and their owners.

Privacy also poses a challenge for BTC wallet providers seeking revenue streams. Kevin Loaec, the CEO of Wizardsardine, the developer behind the Liana wallet, articulated that monetizing wallet services without compromising users' privacy and introducing KYC (know your customer) policies is a complicated task. Therefore, Liana is now trying to find out what people are willing to pay for.

Furthermore, privacy enhancements remain necessary in other protocols, widely embraced by Bitcoin enthusiasts. Take, for instance, the decentralized network protocol Nostr, predominantly used by social network clients. Currently, messages on this network lack default privacy, but solutions are already in progress.

These examples underscore the complexity of the Bitcoin privacy issue and the substantial work that still lies ahead to ensure effective and readily accessible protection for individuals against illicit actors and corrupt power structures worldwide.

Nonetheless, perhaps the primary challenge lies in educating people about the imperative need to safeguard their financial and overall privacy before it's too late.