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What is privacy?

Essentially, privacy is the ability to keep your identity and activity from being seen by others, and this definition applies to the offline world as well as the online crypto space. Here, we’re mostly concerned with crypto, so we’ll be looking at different aspects of privacy in crypto and to what extent they’re possible on “traditional” blockchains such as Bitcoin and Ethereum.

While privacy may seem to be a simple term, it actually includes several different properties of networks such as crypto, from the ability to hide someone’s real life identity to the possibility of tracing a crypto user’s transactions while only being able to tie them to a public address (and not to a real-world identity).

We’ll cover these different aspects in this lesson in terms of how they apply to blockchains that aren’t focused on privacy, before moving on to how some projects are addressing the shortcomings mentioned here in the following lessons.

Anonymity vs. pseudonymity

Blockchains are typically thought to be anonymous and private in general, but this isn’t completely true. In fact, the kind of privacy offered by Bitcoin and Ethereum, for example, can be best thought of as pseudonymity rather than true anonymity. The difference between these two terms is that, for a crypto network to be pseudonymous, it needs to be impossible (or at least difficult) for any third party to connect a user’s publicly-known identity on the network (i.e. their wallet address) to their real-life identity (i.e. their name).

In essence, we can think of a wallet address as a pseudonym, but this doesn’t exclude the possibility of determining which action was done by which pseudonym, or indeed finding all the transaction history and token balances that belong to a particular pseudonym.

For a system to be completely anonymous and private, it needs to do more than that, and here it’s worth noting that the term “anonymous” comes from the Greek term for “without a name,” while “pseudonymous” would be best translated as “having a false name.” So, true privacy and anonymity can only be enabled if it’s impossible to link together the different transactions that were done by the same user, or to find their token balances on the basis of their public address.

Why is this important? If a system is only pseudonymous, then it only takes a very simple slip-up on the user’s part for their entire transaction history to become public. If a user does anything that would link their real-world identity to a wallet address on a blockchain, then everything they own on that blockchain, as well as their entire transaction history, would be known to everyone.

If, however, a system is truly anonymous, then a similar slip-up would only reveal one specific action (for example, the fact that a user received a certain number of tokens at a specific time), while everything else would remain hidden.

Privacy on Bitcoin, Ethereum and similar blockchains

So how do the biggest blockchains of today handle the demands of privacy outlined above?

Typically, they’re pseudonymous, meaning that it’s impossible to connect someone’s wallet address to their real-world identity, but knowing a wallet address is enough to see all the token balances and transactions of that wallet. What’s more, the wallet address or public key is a piece of information that needs to be public, since it’s required for anyone to be able to send tokens to the user.

In other words, if user A wants to send some tokens to user B, they need to know user B’s wallet address, which also lets them see all of user B’s transactions and balances (and vice versa, since B will see which wallet the tokens came from). If user A also happens to know who user B is in real life, then it’s clear that there isn’t much in the way of privacy left in such a system.

There are different ways of addressing this difficulty on the most popular blockchains of today, and that will be covered in the next lesson. Then, we will move on to more innovative approaches that start out with a privacy-centered focus, rather than adding it in at a later stage.