In the early days of Bitcoin, users would send funds to each other using Internet Protocol (IP) addresses. Each device connected to the internet has a unique IP address.
This method worked, but developers soon realized it wasn’t secure. It would be too easy for a hacker to intercept the funds and reroute them to his own device in what’s known as a “man-in-the-middle” attack.
The IP address method was eventually discontinued and the Bitcoin address was born.
Recommended: What is Bitcoin and How Does it Work?
What Is a Bitcoin Address?
A Bitcoin address can come in the form of either a string of 26-35 alphanumeric characters or a QR code. Bitcoin addresses are meant to be used as one-time tokens for single blockchain transactions.
To receive coins, a user must provide an address from their crypto wallet. The technical term for a Bitcoin address is a “public key.”
Wallets contain a collection of public keys that are derived from the private key, which is the key that can unlock the wallet and provide access to its funds.
Why Bitcoin Addresses Exist
Addresses exist as a more secure way for people to send and receive Bitcoin.
The history of transactions on the blockchain is recorded in the form of Bitcoin addresses. Every transaction that has ever been made on the Bitcoin blockchain has been recorded, including the following information:
• The sending address
• The receiving address
• The time the transaction was sent
• The amount of bitcoin sent
• The number of network confirmations
Addresses make it possible for this information to be recorded pseudonymously, in what looks like a bunch of random characters and bitcoin amounts.
Recommended: How Bitcoin Transactions Work
How Does a Bitcoin Address Work?
A Bitcoin address is used to send or receive Bitcoin. Most wallets will automatically create a Bitcoin address with the click of a button.
When we talk about Bitcoin addresses, we’re talking about public keys. Public keys are one half of an asymmetric cryptographic key pair. The other half is the private key. Wallet users sign transactions using the private key and receive transactions using the public key.
Wallet software derives a public key from the private key using cryptographic operations, so it’s safe to share any public key. But sharing a private key can result in theft, as anyone with the private key can access the funds held in that wallet.
A wallet can create many public keys. That’s because receiving coins to the same public key again and again would make it easier for outside observers to link a wallet to a user’s identity.
Are Bitcoin Addresses Traceable?
A Bitcoin address by itself is not traceable, as there is no identifying information stored directly on the blockchain. But there are ways that the identity of an individual can be linked to specific wallets they own and transactions they have made.
This is why Bitcoin is not anonymous — it’s pseudonymous. Wallets and transactions are not linked to someone’s identity, but that doesn’t mean the transactions can’t be traced back to the person who made them.
Tracing a Bitcoin Address
In certain circumstances, it can be easy and simple to track a Bitcoin address. In others, not so much.
Tracing a Bitcoin Address from an Exchange
Because virtual asset service providers (VASPs) like crypto exchanges require users to comply with know-your-customer (KYC) regulations, the exchanges provide one Bitcoin wallet per user. Any transactions going in or out of that wallet will be associated with the person who registered that account — even if the person uses a different public key address for each transaction received.
If someone were to use a crypto exchange-hosted wallet, in theory law enforcement could simply subpoena the exchange for their records and all the user’s transactions would be made transparent.
The exchange knows every public key that the user has ever utilized for their exchange wallet, and anyone can then look at the blockchain data and see every transaction that was ever sent to or from those addresses.
Tracing a Bitcoin Address Without a VASP
If an individual manages to only use wallets of their own, and no VASP is involved, the process becomes more complicated. Advanced computer algorithms can still manage to conduct blockchain money flow analysis. Using sophisticated software to analyze large swaths of blockchain data, companies like Chainalysis could potentially link transactions back to a single user — even if the person used dozens of different wallets and addresses.
Say someone steals a large amount of bitcoin from an exchange. The initial hack will have to take place with a single wallet because the coins that are stolen all at once can only go to one place at first.
From there, hackers usually send coins to many wallets and employ other methods to try and cover their tracks. But being able to identify the first wallet used in the hack often means that blockchain analysis companies can track down most or all of the stolen funds.
Still, there are measures users can take to make it much more difficult for anyone to trace their transactions.
Challenges of Tracing a Bitcoin Address
Although Bitcoin is only pseudonymous, there are ways for users to come close to total anonymity on the network. Here are a few of the most common ways to try to reach this goal.
• Coin mixing: Some wallets lump in several transactions together, making it more difficult to tie a single user to any transaction.
• Multiple wallets: Creating hundreds or even thousands of wallets and using them as intermediaries for many transactions could eventually remove the source identity of the original transactions.
• Running a full node: This requires some technical expertise but is relatively inexpensive and can be done by just about anyone. Routing Bitcoin transactions through a personal node increases anonymity because an outside observer will have trouble distinguishing between the many transactions running through the node. Not only would that user’s transactions go through the node, but also the transactions of thousands of other users.
Combining two or more of these methods may potentially make it very difficult for Bitcoin transactions to be traced. But doing so takes a lot of time, effort, and some extra technical know-how.
The Takeaway
People need Bitcoin addresses to transfer Bitcoin to one another — and the process is similar for most other cryptocurrency types as well.
Privacy in crypto isn’t as universal as many people think, and most transactions can, in fact, be traced. That said, there are methods to make transactions potentially less traceable.
Curious about how to invest in Bitcoin? With SoFi Invest®, investors can trade more than two dozen cryptocurrencies, including Bitcoin, Chainlink, Ethereum, Dogecoin, Solana, Bitcoin, Litecoin, Cardano, and Enjin Coin.
Find out how to get started with SoFi Invest.
Photo credit: iStock/BT Series
SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.sofi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
Third Party Brand Mentions: No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SOIN1021415
Source: sofi.com