Anyone who has paid attention to Bitcoin for more than 15 seconds has heard it's used for drug trafficking and a host of other illicit transactions. I hear this often when talking to people about Bitcoin for the first time, especially if they've only learned about it through media headlines. While it is true that it can be used for illegal activity, so can any other currency – or really anything of value.
If you wanted, you could even trade stamps for drugs. And contrary to popular belief, stamps and other goods are far more anonymous, and thus far more conducive to murky transactions than Bitcoin.
So here's the thing: Bitcoin is pseudo-anonymous at best. A Bitcoin is only anonymous until it goes through a phase change. The moment you change Bitcoin to something else such as fiat currency, goods, services or anything else, suddenly they are tied to you.
But it's more significant than that for the privacy crowd. Not only is that transaction suddenly no longer anonymous, but every transaction that's ever happened with those Bitcoins is now tied to you, however tenuously. Unlike with fiat currency, or currency deemed to have value by government regulation, Bitcoins have an unbroken lineage from the moment they're mined to where they are now – and that information is all public and easily accessible.
Conversely, if I receive a dollar bill from someone, I know who I received it from, but in most cases I have no idea who had it before. If I get a Bitcoin from someone, I know who I received it from, who they received it from, and so on, down the chain, all the way until it first came into existence. Not only is Bitcoin a less-than-anonymous currency, it is a law enforcement dream come true.
The lineage of funds can be traced and identified with perfect clarity, and while it is possible to use Bitcoin anonymously, it's very hard to do so. Not only that, but mistakes at any one point in the process of remaining anonymous makes everything done with those Bitcoins in the past and in the future suddenly traceable. Those "party favors" you bought on Silk Road two years ago? Now they point directly to you.
There are ways to increase anonymity – mixers and tumblers come to mind – but in today's world of complex data mining, warrantless search and seizure, and behavior profiling, they offer little protection against a determined investigation.The public block chain, while one of the single greatest inventions in the history of currency, is a double-edged sword for anyone using it for illegal activity. Those who aren't extremely careful will eventually get cut. If you want to do something truly anonymous, your best bet is still to pull out that wad of cash, hand it over and walk away.