Restoring Bitcoin Privacy
The combination of Know Your Customer and Anti-Money Laundering laws and chain analysis are harmful to Bitcoin privacy and, by extension, Bitcoin fungibility. To maintain Bitcoin’s private, free nature, many developers are actively working on ways to make chain analysis heuristics obsolete and ensure that Bitcoin users can continue to transact pseudonymously.
Additionally, off-chain protocols such as the Lightning Network, Liquid Network, and others offer the ability to execute Bitcoin transactions without publishing data to the Bitcoin blockchain.
CoinJoins are a simple and effective way for a user to gain privacy and obfuscate which bitcoin they own. A CoinJoin is a large Bitcoin transaction which takes inputs from many different users and returns many outputs of identical amounts, so that an observer cannot easily determine which outputs belong to which of the participants. JoinMarket, Wasabi Wallet, and Samourai Wallet all offer implementations of CoinJoin protocols to help protect user privacy.
CoinJoin transactions help break the common input ownership heuristic, which assumes that all inputs of a transaction are owned by the same entity. By ensuring the outputs are of identical amounts, CoinJoins also break the round amounts heuristic.
PayJoin, CoinSwap, and More
CoinJoin implementations are fully operational, well-established, and fairly liquid today. The main issue with CoinJoin transactions is that they are fairly noticeable: they involve many inputs and outputs and the outputs all contain identical amounts. However, many projects are working on alternative privacy technologies which are more subtle or provide stronger guarantees than CoinJoin.
Projects such as PayJoin (P2EP) and CoinSwap are attempting to improve upon CoinJoin’s privacy benefits while remaining indistinguishable from regular transactions. In the near future, these technologies will undermine many of the deanonymization strategies currently used by chain analysis.
The Lightning Network
The Lightning Network was built to scale Bitcoin and enable instant, cheap payments. Because of its decentralized and peer-to-peer nature, Lightning is also a highly private network. Instant and free payments can be executed without the knowledge of anyone but the payer and payee, and Lightning payments are not recorded on any public ledger. The Lightning Network also uses onion routing for routed payments. This makes Lightning payments difficult to track.
Practically speaking, if you use a Lightning-enabled exchange like River, you could withdraw funds via Lightning to a self-custody wallet like Breez or Phoenix. Once your funds are in that self-custody wallet, you could choose to do another “hop” to a different self-custody wallet like Blixt, or you could withdraw your LN funds on-chain. Using this strategy would provide a greater degree of privacy on-chain, and depending on the number of hops, your Lightning privacy could be greatly improved, too.
Sidechains are blockchain networks built to integrate with the Bitcoin blockchain. Sidechains offer yet another way to achieve privacy using Bitcoin. For example, the Liquid Network enables bitcoin tokens to be turned in for Liquid tokens on the Liquid blockchain, where they can be moved cheaply and pseudonymously. At any time, the Liquid tokens can be swapped back to bitcoin tokens on the Bitcoin blockchain.
Unlike the Bitcoin network, the Liquid blockchain enables transactions that hide the amounts being sent, affording Liquid users stronger privacy against third parties. However, the Liquid Network is not fully decentralized. Instead, it is governed by a federation of entities, who are trusted to maintain the network honestly.
Bitcoin and Privacy
Achieving privacy using the Bitcoin network is possible today, and thanks to the effort of privacy-focused developers, it will likely be possible in the future. However, privacy is a constantly escalating arms race between surveillance companies and governments and individuals. For every privacy technology invented, a surveillance technology is not far behind, and vice versa. Therefore, maintaining privacy requires vigilance and maintenance over time.