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The significant limitations of Bitcoin with respect to user privacy have pushed the Bitcoin community to design mechanisms that ensure privacy-preserving payments in Bitcoin.

In this section, we overview and analyze proposals for strengthening privacy in Bitcoin. We start by describing mixing services, and then proceed to describing other crypto-based privacy extensions of Bitcoin. Mixing services achieve user privacy in a holistic way (i.e., in both the network and protocol layers) without degrading payment performance, but require absolute trust in a third-party. In contrast, cryptographic extensions of Bitcoin eliminate the need for trusted third- parties but tend to be taxing in terms of performance.

Mixing Services

Mixing services play the role of trusted mediators between the users and the Bitcoin system, allowing to some extent the mixing of coins pertaining to several users—thus effectively preventing the public traceability of coin expenditure in the network.

The first mixing services (also called tumblers) mix one’s funds with other people’s coins with the intention to confuse the trace back to the funds’ original source. In traditional financial systems, the equivalent would be moving funds to banks located in countries with strict bank secrecy laws, such as the Cayman Islands, the Bahamas, and Panama.

The operation of a Bitcoin mixer is summarized in Figure 5.1. Users who make use of a mixing service for their payments are usually asked to open an account at that service, which serves as an out-of-band communication channel. Through this channel, the user and the service agree upon a service-owned address to which the user sends his payment. Assuming an honest service that has a nonnegligible number of registered users, there are two models to which such a service can fulfil its purpose:

Coin history resetter Here, the mixer sends back to the user someone else’s coins of the same value. Clearly, in this case the user also needs to provide the service with a return address. From this point onward, the user can pay the intended recipient with the fresh coins that he or she received from the service. BitLaundry [18] and Bitcoin Fog [19] are some of the mixers operating under this model. Note that this model does not resist network layer attacks since the user is eventually making the payments.

Payment mediator Here, the mixer keeps the funds, circulates them among its other addresses, and finally pays the recipient of the payment as indicated by the user. [20] and most online wallets operate in this fashion. Unlike the first model, this variant model resists network layer attacks on the user since the mixer is issuing the payments on behalf of users.

Mixing services usually charge a commission on the payment the user wishes to perform or on the value of the coins exchanged. Though mixing services offer—to a large extent—obfuscation of user payments, their impact on the privacy of user- transactions at the protocol layer has not been thoroughly assessed (up to the time of writing). At the same time, mixing services require absolute trust in the service itself that has the power to steal users’ funds.

A mixing service acting as a payment mediator

Figure 5.1 A mixing service acting as a payment mediator.

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