Many cryptocurrency users believe that dealing in digital assets provides them with complete anonymity. That’s not strictly true, since most cryptocurrency transactions aren’t as anonymous as you might think. Blockchain analysis techniques, which are becoming more sophisticated over time, mean that it’s no longer near impossible to link a wallet address with a real person.
Those who are particularly careful about their privacy now take extra precautions to conceal their identity — one of which is to use coin mixing or CoinJoin solutions when conducting sensitive transactions. In this AAG Academy guide, we’ll explain what coin mixing and CoinJoins are, how they work, and the risks involved for those who use them.
If you were to pay your friend $10 in cash for a product or service, that money is almost totally untraceable. It would be difficult to prove the money came from you, who might have held it before you, or where it went if your friend decided to spend it. Some believe that digital assets or currencies like Bitcoin provide the same level of anonymity, but that’s not entirely true.
While cryptocurrencies bolster our privacy somewhat with the use of obscure wallet addresses and by providing us with the ability to transact without having to prove who we are, methods of linking a wallet address to an actual person are becoming more effective. What’s more, the public nature of most cryptocurrencies means that coins and tokens are easily traceable.
If you had paid your friend with $10 worth of Bitcoin (BTC) instead, it’s not only possible for anyone to see that transaction on the blockchain, but it’s also possible to trace where that BTC has been before — and where it went if your friend transferred it to someone else. Coin mixing and CoinJoins are two ways you can prevent that.
What is coin mixing?
Coin mixing in the cryptocurrency industry refers to a process whereby users exchange their coins or tokens for other cryptocurrencies that are in no way linked to the funds they originally held in their wallet. This service is usually provided by a third-party service that charges a small fee, and they can pay a recipient directly, leaving your wallet address out of the equation.
Coin mixing services, which are also referred to as “mixers” or “tumblers,” claim that any funds they use to facilitate your transaction cannot be traced back to you. And there are lots of legitimate reasons why you might want to use a service like this, like hiding certain purchases that you wouldn’t want a partner or employer to see on a public blockchain.
Because of this, coin mixing services are seen as a positive thing by many privacy advocates. However, they are somewhat controversial among other groups due to the nature of the service they provide, which naturally attracts those who are using cryptocurrency for more nefarious activities. Coin mixing services are legal to use in most regions despite these concerns.
How does coin mixing work?
To explain how coin mixing works, let’s continue with the example we used above: Let’s say you want to pay your friend $10, and for whatever reason, you don’t want anybody to know about it. You can’t pay them in cash, so you choose to use cryptocurrency, but you’re worried that the transaction could be linked back to you by your wallet address.
So, instead of paying your friend directly, you send $10 worth of cryptocurrency plus a small fee to a coin-mixing service. The coin mixer then “mixes” that cryptocurrency into their pool and pays your friend using other coins or tokens that cannot be linked back to your wallet — or to the cryptocurrency you originally sent. Alternatively, “unlinked” coins can be sent back to you.
By using this process, it becomes even more difficult for anyone to identify that the cryptocurrency received by your friend is in any way connected to you. However, it may not be impossible — something we’ll look at later in this guide.
What is a CoinJoin?
An alternative to a coin mixer, which may be more effective and more secure, is a CoinJoin. Using a CoinJoin achieves a similar outcome, however, instead of swapping one cryptocurrency for another that promises to be unlinked, they combine the inputs and outputs of multiple users into a single transaction to make it impossible to say for certain which user paid which recipient.
The CoinJoin system was first proposed by Bitcoin developer Gregory Maxwell in 2013. In his original thread on the subject, Maxwell noted that Bitcoin wallet addresses are “fragile and easily compromised through reuse,” and therefore aren’t enough to protect a user’s privacy. His solution required no changes to the Bitcoin protocol and brought significant privacy gains.
The easy implementation of CoinJoins is one of the reasons why they have become so popular for those looking to conceal Bitcoin transactions. And, unlike coin mixers, CoinJoins do not rely on a third-party, so there’s no need to trust someone else with your cryptocurrency or pay an additional fee to use one — aside from the usual transaction fee.
How does a CoinJoin work?
A CoinJoin is a little more complex than a coin mixer, but we can make them a little simpler to understand by first breaking down a Bitcoin transaction. Every transaction is made up of inputs and outputs, which you can think of as debits and credits. If you were to send 1 BTC directly to a friend, it would be debited from your wallet and credited to theirs.
A direct transfer of funds like this might have just one input, which is signed by the sender, and just one output. This makes it easy to see which wallet sent that 1 BTC, and which wallet received it — there is no ambiguity. But let’s say that instead of sending that 1 BTC directly to someone else, you combine your payment with those of other users.
Now, instead of just one input and one output, there are multiple inputs — each of which are individually signed — and multiple outputs in a single transaction. Because of the way these payments have been combined, it’s no longer possible to say with certainty which input, or which sender, is responsible for which output.
CoinJoins rely on multiple users coming together to combine their payments, one of which may coordinate the transaction and put all the pieces together. However, there is no need for a third party, which means there are no additional fees to pay outside of the standard transaction fee, and no need to trust another party with your assets.
What are the risks with coin mixing?
Coin mixing has its advantages, one of the biggest of which is convenience, but there are risks you should watch out for, too. Whenever you trust a third party with your assets, there is always a possibility that they could disappear with them. This may be less of a worry if you’re using an established and trusted coin-mixing service, but that doesn’t eliminate risk entirely.
Furthermore, there are concerns over just how much coin-mixing services can really protect our privacy. There’s no guarantee that the “unlinked” cryptocurrencies they offer in return for those we hold really are unlinked, or that they aren’t tainted in some other way. There are also concerns that mixed coins may not be as untraceable as they claim to be.
It’s safe to say that some mixing services are more effective than others at this, but no matter which one you use, there’s also the risk that your cryptocurrency could become useless in other places. Some exchanges can identify mixed coins and won’t accept them. For instance, Binance has blocked withdrawals to certain wallet apps primarily used for mixing.
Using a CoinJoin combines a cryptocurrency transfer you’re making with those of other users, so a single transaction ends up with multiple inputs and multiple outputs. It is therefore impossible to tell which input, or which sender, is responsible for which transfer.
Anyone who wants to ensure that their cryptocurrency transactions are as private and as untraceable as possible might want to use a coin mixer.
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About the author
Senior content writer
Senior copywriter for AAG Marketing team with the focus of educating our community on all things web3, blockchain and Metaverse.
This article is intended to provide generalized information designed to educate a broad segment of the public; it does not give personalized investment, legal, or other business and professional advice. Before taking any action, you should always consult with your own financial, legal, tax, investment, or other professional for advice on matters that affect you and/or your business.