Thursday, May 15, 2014

Review of "Anonymous Bitcoin"

Tax evasion is a crime in all countries, big and small, dictatorships and democracies. All nations want to keep an eye in their money, I mean in their citizens’ money, because taxation is the lifeblood of modern states, without it there will be no armies, public teachers, judges, policemen or politicians. The IRS estimates that from 2001 to 2010 the federal revenue lost $3 Trillion to tax evasion, which is amazing, specially if we take into account that tax fraud may result in huge fines and imprisonment.

In the pre-Bitcoin world it was very complicated to hide money from the scrutiny of the Government. Lying to the IRS was not a good strategy in the long run. The most effective way of hiding your money was sending it to a tax heaven, which was not easy since all banks and financial institutions are obliged to inform the authorities of all transactions made by their clients. The best way to send money anonymously was transferring physically cash, which is very complicated and only makes sense for big quantities.

Bitcoin is not only a currency, it is also a frictionless system of payment. If deals made with Bitcoins are anonymous, it would represent a serious threat to the IRS, because transactions out of the US without friction or scrutiny would be available to everyone. Therefore, all residents could easily avoid paying taxes. But are Bitcoins really anonymous?

Anonymity is a key word when it comes money. However, it is not a concept that it is easily understood. Kristov Atlas in his book “Anonymous Bitcoin” tells us that anonymity is not a binary concept. It is a probability of being identified. He gives the example of an investigator who is trying to solve a murder mystery. If he does not know anything about the murder his probability to find the murderer is one out of seven billion (the population of the world). If he knows that the murderer is a woman, his probability is one out of 3.5 billion. If she lives in Philadelphia the probability to identify her is one out of 750,000 (half of the population of Philadelphia), and so forth. Basically, the more he knows about her, the less anonymous she is. This definition challenges our imperfect intuition that anonymity is to know or not to know the authorship of an act, as if the world was black and white without an infinite array of grey and colors.

Kristov Atlas shows us that the blockchain is not safe for those who want to keep their identity private. The blockchain is a public ledger of all transactions in the Bitcoin network. In some way is as if all your bank account information was public for everybody to see. Thankfully, there are some mixing services to mix one's funds with others', with the intention of confusing the trail back to the funds' original source to anonymize the ownership. Kristov Atlas makes a case for implementing a mixing protocol within the Bitcoin protocol itself. Basically he thinks that the developers should update the protocol to make all transactions completely anonymous. I do not think that the IRS will be happy with that when it happens. Time will tell.

Anonymous Bitcoins” is a very easy to read book that contains a lot of examples so that anyone can understand all concepts. It includes an introduction to Bitcoins and a walk-through on how to use a mixing service. I strongly recommend it to anybody who wants to understand a little bit better the Bitcoin ecosystem.

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