Decentralized Identity Management

This brings us to the idea of decentralized identity management. Rather then having a central authority for registering users in a system, you can register as a user yourself. You don't need to be issued a username, nor do you need to inform someone that you're going to be using a particular name. If you want a new identity, you can just generate one at any time, and you can create as many as you want. All these things are possible with decentralized identity management, and this is the way Bitcoin, in fact, handles identity. These identities are called "addresses", in Bitcoin jargon. You'll frequently hear the term "address" used in the context of Bitcoin and cryptocurrencies, and it's really just a hash of a public key. It's an identity that someone made up out of thin air, as part of this decentralized identity management scheme.

As first glance, it may seem that decentralized identity management leads to great anonymity and privacy. After all you can create a random-looking identity all by yourself without telling anyone your real-world identity. But it's not that simple. Over time, the identity that you create makes a series of statements. People see these statements and thus know that whoever owns this identity has done a certain series of actions. They can start to connect the dots, using this series of actions to make inferences about your real-world identity. An observer can link together these observations over time and make inferences that lead to such conclusions as, "Gee, this person is acting a lot like Joe. Maybe this person is Joe."

In other words, in Bitcoin you don't need to explicitly register or reveal your real-world identity, but the pattern of your behavior might itself be identifying. This is the fundamental privacy question in a cryptocurrency like Bitcoin.

Reference:

Narayanan, Arvind, et al. (2017). Bitcoin and Cryptocurrency Technologies. United States: Princeton Press

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