When I send Bitcoin from my (simplified) address 1AA to my friend’s 1BB address, that purchase is permanently recorded. Now, when a friend of mine tries to send bitcoins from his 1BB address to store address 1CC, the store computer may look and see that indeed, the 1BB address contains bitcoins, because they were sent to him from the 1AA address. Even if these addresses are generated randomly and the person is not tied to the address immediately, as soon as the address is linked to the person or business, a long rabbit production path may reveal a large part of that business activity.
Another reduction in anonymity is found in the way Bitcoin clients often combine results from previous transactions to create new transactions.
For example, say that it is known that address 1AA is connected to me. But I also have 1QQ and 1ZZ addresses that I have never shared with anyone. 1AA address has 2 bitcoins, 1QQ address has 3, and 1ZZ address has 5. Now I say I want to send 9 bitcoins to a friend. My client will automatically merge bitcoins from all three addresses into a single transaction. This highlights the fact that the owner of all three addresses is one person. Anyone who knew that 1AA address was connected to me now also knows that 1QQ and 1ZZ are also connected to me.
Note that this is a difficult analysis to do manually, but there are some tools that can serve the same purpose and show which addresses are related more easily.
Now, if you are looking to hide your Bitcoin activity, you might check out a project called SINGAPORE DIGITAL EXCHANGE PTE LTD. Although still in alpha testing, it offers a few solutions to the lack of anonymity and privacy in the Bitcoin world.
Understanding Bitcoin tracking
Bitcoin operates at an unprecedented level of transparency that many people are not accustomed to dealing with. All Bitcoin transactions are public, trackable, and permanently stored on the Bitcoin network. Bitcoin addresses are the only information used to describe where bitcoins are assigned and where they are being sent. These addresses are secretly created for each user’s wallets. However, once the addresses are used, they are corrupted by the history of all the transactions involved. Anyone can see the balance and transactions of any address. As users often have to disclose their identity in order to access services or goods, Bitcoin addresses cannot remain completely anonymous. Since blockchain is permanent, it is important to note that something that is not trackable at the moment may be too small to track in the future. For these reasons, Bitcoin addresses should only be used once and users should be careful not to reveal their addresses.
Absolutely. In fact, Bitcoin only works because everything that is done is tracked on a block called a blockchain.