Bitcoin Privacy: The Path to True Final Settlement

Despite the aforementioned cryptographic hash function, and pioneering the very concept of “cryptocurrency”, the crypto part of Bitcoin relates to transaction integrity rather than privacy.

A guest post from Shane Neagle, Editor In Chief from The Tokenist.

In the digital age, financial privacy has become a pressing issue as surveillance is inherently ingrained in all electronic transactions. Each transaction generates bits that can be aggregated, stored, revisited, abused, funneled and manipulated. Theoretically, the 4th and 5th amendments of the U.S. Constitution provide a bulwark against 3rd party transaction interception.

But a rule written on a piece of paper is only as relevant as there is will to interpret it or enforce it. A more robust solution must come from a hard technological source.

Besides fixed scarcity to 21 million BTC, the underlying draw of Bitcoin is that its network makes transactions inviolable.

Bitcoin mainnet achieves this through escalating confirmations. The first confirmation means that a transaction is included in the blockchain’s block. All subsequent blocks added embed the transaction further into the chain. By the sixth confirmation, a would-be attacker would have to mine 6 consecutive blocks faster than the rest of the Bitcoin mainnet combined.

At this point in time, the energy expenditure (hashrate) necessary for such a feat makes this virtually impossible. This is also the reason why Bitcoin’s proof-of-work is so integral to the underlying value of Bitcoin vs proof-of-stake that is so pushed by Greenpeace.

The rule of 6 confirmations therefore became the de facto standard among developers, miners and exchanges. After that 6th confirmation threshold, a BTC transfer is deemed as “final settlement”, or irreversible.

But is a transaction genuinely irreversible if it is not private, therefore vulnerable to seizure by either governments or criminals? First, let’s examine what Bitcoin settlement entails.

Understanding Final Settlement in Bitcoin

Satoshi Nakamoto’s peer-to-peer money transfer system revolves around proof-of-work. Truly revolutionary, it makes it possible for a payment system to work by itself. In other words, to be trusted because it is trustless. From initiating a transaction to making the transaction irreversible, the final settlement process follows multiple steps:

As a matter of historical practice and analysis, the 6-block confirmation rule additionally secures the finality of those transactions. Due to network latency, it is possible for another miner to simultaneously find a valid block. In such a scenario of divergence, two blockchain states exist, so the longer chain is recognized by the network as valid, while the competing chain (orphan) is disregarded.

This also impedes malicious actors from reorganizing the chain in order to reverse transactions. By how much?

According to the “Practical Settlement Bounds for Proof-of-Work Blockchains” paper by Gaži, Ren and Russell, a 6-block confirmation yields 0.48% settlement error guarantee, while assuming 10 second network latency (delay) and 10% adversarial computation power of the network.

While that percentage is exceedingly low under such harsh conditions, it is still not zero, which implies that settlement “finality” is still probabilistic. Rather, it is statistically improbable. And if that is the case, how should Bitcoin settlement be treated?

In his paper “Probabilistic Settlement Finality in Proof-of-Work Blockchains: Legal Considerations”, Hossein Nabilou at Amsterdam Law School argues that operational finality should be differentiated from legal finality.

But because “institutional mechanisms to deal with the remaining risks of settlement finality require a certain level of centralization in the PoW blockchains”, the solution would have to come from “market-driven mechanisms”. At the time in 2022, the author was pessimistic about their emergence.

The Privacy Gap in Bitcoin Transactions

Despite the aforementioned cryptographic hash function, and pioneering the very concept of “cryptocurrency”, the crypto part of Bitcoin relates to transaction integrity rather than privacy. Cryptographic hash function, combined with a nonce, makes it extremely difficult to tamper with Bitcoin settlements as it prevents double-spending attempts.

This cryptographic security is also critical to the infrastructure behind bitcoin payment processing services, which rely on the immutability of the Bitcoin network to ensure secure and accurate transaction settlements.

But by the nature of a self-contained network, Bitcoin incidentally offers pseudo anonymity. That level of privacy is instantly breached once an identity is attached to a Bitcoin address, leaving behind a digital trail. This is what eventually led to the arrest of Ilya Lichtenstein and Heather Morgan, responsible for the Bitfinex exchange hack in 2016, worth around $4.5 billion in BTC.

“In a futile effort to maintain digital anonymity, the defendants laundered stolen funds through a labyrinth of cryptocurrency transactions.”

From this perspective, Bitcoin’s cryptographic hash should be understood as a digital signature (ECDSA) to verify authenticity, as all the transactions are visible on the public blockchain. Notwithstanding if financial privacy is constitutional or natural right, does that mean that Bitcoin cannot supply it?

What if one finds themselves in a tyrannical country and

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