Bitcoin Segmentation: The Good, the Bad, and the Ugly

A Little Bit of Money

Thought Experiments on Cross-Border Payments - Of Couriers, Bankers, and Bitcoiners

Series 4: Bitcoin Segmentation: The Good, the Bad, and the Ugly

Bitcoin is Pseudo-Anonymous just like Dark Pools

Pseudo-anonymity is nothing new in the financial world. Present day stock exchanges, interbank currency marketplaces, and dark pool multilateral trading facilities utilize pseudo-anonymity within their dealing systems. However, markets are not always complete black boxes. Participants’ identities are almost always verified in the back office. The same applies to Swiss-numbered accounts today. 

Numbered bank accounts are pseudo-anonymous

They are not anonymous anymore; they are pseudo-anonymous. That is, the account will have a codename, but the customer’s actual name will not appear on bank statements. This means that if bank statements are stolen or bank systems are compromised, the customer’s name is not easily viewable, thus preserving confidentiality in the event of cybercrime. Account holder details are known to the bank and disclosed only on a need-to-know basis. Otherwise, the account holder is not exposed to the public. 

Associating Identities to Transactions

Bitcoin`s pseudo-anonymity utilizes public keys and private keys. Transfer records contain these digital signatures as well as transmission times, inputs, outputs, and amounts. Pseudo-anonymity can be enhanced by associating customer identities to make Bitcoin transactions AML-compliant. Right now only a few companies have proprietary software in place to identify Bitcoin transaction details, as well as monitor and identify suspicious patterns. In the future, there will be a clear division: Bitcoin companies that actively perform AML and combat the financing of terrorism will be distinguished from those who do not. Market players are going to be divided into those that are AML-compliant and those that are not.

Managing Identities of Transactions Behind the Scenes

With crypto currency, AML compliance can be done the same way as with a numbered account, or perhaps even better. In public, transactions use pseudonyms to stay confidential, but the bank’s back office retains the right to de-anonymize the account behind the scene. Technology can help by assigning validated legal identities to digital cash transactions, making sure users are the users they claim to be. The missing link is associating the public address with a person. Such AML/KYC-procedures can be performed off-chain through traditional verification systems at the time of onboarding.

To be continued. Further Reading:

  • S. Masunaga and R. Ranoa. “How Bitcoin Works.” The Los Angeles Times. May 6, 2016.
  • P. Crosman. “Can You Really ‘Know’ a Customer Who Uses Bitcoin?” American Banker. December 1, 2015.
  • R. L. Ensign, “The Morning Risk Report: Virtual Currency Firms Struggle with AML.” The Wall Street Journal Risk & Compliance Report, May 7, 2015,

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