If your government came up with a device that listens to you 24/7, tracks your exact location, and keeps logs of all of your purchases and conversations, you would call it Orwellian and immediately start a rebellious movement to overthrow the establishment. But when a private (but compliant) company develops a device that performs all of these surveillance tasks while allowing you to benefit from convenient features, it’s all fine because you still exercise some free will. Hell, why not let them take your pulse, fingerprint, and face scan as well?
The exact same goes for Bitcoin. Governments could overregulate and discourage anyone from using the currency. They could create legislative frameworks to make every citizen declare all public keys, wallets, and transaction recipients. But why bother risking an uprising when all private companies are already obliged to disclose information about their business and customers? At first, the information goes to the tax administration authorities (IRS, HM Revenue & Customs, ministries of finance). Afterwards, other intelligence agencies can store the data for a number of years and even extend their mandate beyond the social contract.
This is how we get Bitcoin debit cards, dedicated cashback programs, and institutionalized banking. All of these services are reminiscent of the traditional financial system and demand mandatory KYC/AML. In exchange for information about your shopping data and bitcoin holdings, you’re going to receive rewards for every purchase that you make. By depositing your bitcoins to a compliant institution, you’re going to earn 4% interest every year. And by registering to this car manufacturer, you will be able to buy a brand new automobile with your BTC.
Governments don’t really need to overregulate Bitcoin – they just need to make sure that every onramp and offramp gets registered with an ID or passport. From this point on, private companies will keep track of your transactions and send reports about your activity to government agencies.
You might think that all of this is alright and only part of Bitcoin’s integration to traditional finance. And you’re partially right, except that you’re actively contributing to the destruction of bitcoin’s fungibility. Every coin you integrate into the regulated and compliant system is going to get tracked – and it’s likely that once it ends up in the hands of an institution, it will never become free of taint and get transacted only after an institutional contract gets signed.
Therefore, the holder of these coins will never be unknown. So if the number of bitcoins with unknown ownership diminishes, then it becomes a lot easier to identify the owners. The plausible deniability fades over time and we get more precise blockchain analysis.
Why Bitcoin’s Fungibility Matters
In case you are not aware, fungibility is an essential property of money. It means that 1 unit can be traded for any other of the same value. You can exchange one US dollar bill which previously belonged to a convicted criminal for one which was freshly printed last week, and you will never have a problem. You can trade a gold necklace for a gold ring of the same weight, and the two pieces of precious metal can get melted to never reveal their previous shapes and whereabouts.
But in the case of Bitcoin, every monetary unit has a history of its own that can be tracked on the public blockchain. Every full node stores the history of transactions, and anyone can verify when a new block got mined and where the reward had been sent. If you don’t want to deal with all the technical intricacies, you can even use a blockchain explorer and type in any address name, transaction ID, block height, or hash.
Sure, the whereabouts of coins have been scrambled since they first entered circulation as mining rewards – but with enough data about who operates nodes and who generates receiving addresses with an xpub, you can find out just enough information.
In a situation where most users keep their coins on exchanges, there is zero anonymity. We have even seen ironic paradoxes where presumed privacy coins likes Zcash get listed and traded on exchanges, while clueless investors think that they get the benefits of shielded transactions under a controlled panopticon.
Yes, this level of transparency has helped Bitcoin earn everyone’s trust. Early adopters could trust that there is no hidden inflation and they can trust the programmed monetary policy. Later on, governments didn’t find Bitcoin dangerous enough to ban it. So we may regard it as a Trojan horse which makes everybody underestimate the power of Bitcoin.
But it’s still important to maintain a level or transaction privacy. A bitcoinized world where private companies and governments know about the money you own and the transactions you make is not much better than the system we already have.
Bitcoin Privacy Matters and We Must Popularize It
Yes, CoinJoins can add extra friction and add plausible deniability. Yes, the Lightning Network makes transactions instant and a lot more private with Tor-like routing. And yes, the Liquid sidechain has confidential transactions and it’s likely that other sidechains will also add features for extra fungibility.
But these transactions are still a negligible part of the Bitcoin economy. For every Wasabi and Bisq Network user, there are dozens of people who keep their coins on exchanges because they believe in the “insurance” or have fear of self-custody. For every privacy advocate there is a significantly higher number of people who buy into the justifications for mass surveillance while arguing that they have nothing to hide.
While it’s fun to cheer when Michael Saylor and Elon Musk announce new significant purchases for their companies, we must also be aware that their actions are detrimental to the idea of Bitcoin privacy. After registering the coins under in the reserves of their publicly-traded companies, they will only leave the vaults after signing contracts that will never remain private.
A good first step in the right direction would be to realize how valuable bitcoins are and how they can guarantee sovereignty and freedom in a world where fundamental human rights get suppressed even in the most consolidated democracies. No other form of money allows you to cross national borders to escape authoritarian regimes while holding nothing but a notebook, a computer file in your laptop or phone, or a sequence of 12 words that you memorize. And no other form of money is exempt from arbitrary confiscation when held in self-custody.
A second step in the right direction would be to use more peer to peer services and support a parallel bitcoin economy. Do you really need to buy a Tesla with your bitcoins? Because there are lots of regular users who would probably sell their cars for BTC. And there are lots of artists, professionals, and freelance workers who would gladly take peer to peer BTC payments. Need some fiat money? How about you use a non-KYC ATM or get on a service like Bisq or HodlHodl?
We are dealing with a situation of excessive financialization that has already compromised the privacy and fungibility of Bitcoin. Exchanges like Coinbase will even track your transactions after you withdraw the coins from their custody – ever heard of a bank which hires private investigators to figure out how you’re spending the cash that you withdrew from their ATM? The situation is very serious and it’s not getting any better unless we take action.
A good third step would be to CoinJoin more often, so this mixing becomes the norm as opposed to a niche activity between niche enthusiasts. If the privacy advocates are known to CoinJoin, then it’s not really hard to identify the addresses of one of them and then use deduction to figure out who everyone else is.
The lower the number of CoinJoin participants, the lower the actual privacy. Of course exchanges will reject coins associated with mixing and refer to them as potentially resulting from criminal activity. It’s in their best interest to collect as much user data as possible, just like it’s in the governments’ best interest to surveil while maintaining an appearance of concern for human rights.
If you’re reading this, then it’s time to take action and help make Bitcoin more private and fungible. As I said in a previous article, the institutions can’t wait to buy our bitcoins – because it’s their guaranteed way to escape taxation and inflation. And along the way, they will gladly reward HODLers with nice houses, cars, and crops of land. To them it’s a small price to pay for all the benefits of holding BTC. So before you sell next time, think twice about the kind of asset that you’re letting go.
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