In Part One[1] of this treatise, we examined the fundamental relationship between Bitcoin and privacy by going back to the beginning with the whitepaper. In spite of some excellent privacy preserving options that have been available to users since those early days, we seem to have taken a few wrong turns. But to fix it, in order to make Bitcoin’s privacy “great again,” we must be able to distinguish between real privacy and red herrings that can only lead us further off the path.
Fiat Gateways Lead to Privacy Graveyards
Bitcoin is an effective system to transfer and store wealth, but that wealth has first to “enter” the system somehow, very often coming from fiat money. (Of course, you can also earn satoshis directly in exchange for goods and services you provide, instead of buying them with fiat.)
Fiat-enabled bitcoin on-ramps (often known as “cryptocurrency exchanges”), acting as liquidity bridges, created huge privacy problems in Bitcoin. In order to manage fiat, exchanges will have to use traditional bank accounts. In order to get those, they have to meekly accept all the rules, conditions and limitations banks require. Traditional fiat banks, in turn, will pass over the extremely complex and heavy “compliance” burden they received from governments and regulatory agencies, including that concentration of economic illiteracy called “KYC/AML regulation.”
So, fiat-to-bitcoin bridges will almost always end up demanding a scary amount of personal information from their user, linking that information to a few deposit and withdrawal addresses (often incentivizing continuous reuse) and then even hiring “chain-analysis” companies in order to follow, trace, tail and stalk all the previous and following economic activity on-chain.
Why Chain Analysis?
The first and most important reason for doing so is because these on-ramps are scared to lose the privilege of having a
