It’s a common impression that Bitcoin is a decentralized cryptocurrency built on blockchain technology in which transactions are anonymous and untraceable, hence, the central government has little or no power to control the system. While it is true that Bitcoin transactions are decentralized, it is not entirely true that they are untraceable. 

The blockchain is a public ledger where every crypto transaction is recorded publicly and can be viewed by anyone on the blockchain, hence, Bitcoin transactions on the blockchain can be viewed by anyone on the blockchain.

However, it is impossible to know the identities of the people behind these transactions without analyzing and tracing the Bitcoin addresses behind the transactions. By tracing the addresses, the government in coalition with law enforcement agencies like police, Internal Revenue Service(IRS) can track these transactions and get the information needed for investigation purposes.

Tracking Bitcoin transactions is not an easy venture because it requires a huge amount of time and most importantly, the right technology and expertise. Nonetheless, recently, centralized crypto exchange platforms are making the job less cumbersome for the government due to their Know-Your-Customer (KYC) policy which mandates users to register their personal details. 

In this article, we will discuss how governments can track Bitcoin transactions and how possible this can be.

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How Does Government Track Bitcoin?

One may wonder how the government can possibly track Bitcoin transactions despite the transactions being anonymous. 

The government through law enforcement agencies like the police or IRS can trace Bitcoin transactions by observing and analysing the transaction patterns with the aid of blockchain analytics experts to identify and deanonymize the parties involved.

A company like Chainalysis provides blockchain monitoring and analytics services to the government. They monitor, analyse and track Bitcoin transactions to identify if they are linked to some criminal activities, hence collaborating with law enforcement with tracking the identities of the users.

The major aim of tracing Bitcoin transactions is to identify which are involved in some illicit activities. Even though most Bitcoin activities are not linked to criminal activities, law enforcement agencies believe that some criminal activities like money laundering and terrorism are still propagated through Bitcoin.

Also, a body like the IRS is interested in tracking Bitcoin transactions and investors not because they may be linked to criminality but to raise taxes from Bitcoin capital gains.

Does The Government Know When And Where Bitcoin Is Bought?

It’s impossible to say that the government does not know when and where Bitcoins are traded because the government can easily access such data from centralized exchanges.

A centralized exchange is one that is owned and controlled by a single entity, such as Binance and Coinbase. A centralised exchange must comply with the rules of the country or territory in which they operate before it can become a licensed operator in such a place.

A good example of how government can easily get data from centralized exchanges is through the Know-Your-Customer (KYC) policy incorporated by most centralized platforms

KYC demands all customers submit their personal details for verification before they can be allowed to transact, invest or withdraw from such exchanges.

The KYC policy was introduced to eliminate illicit use of cryptocurrencies and decrease crypto transactions’ anonymity. Therefore, the government can mandate the exchanges to share the KYC data with law enforcement to identify Bitcoin wallets and trace crypto transactions If need be.

However, decentralized exchanges are unlikely to adopt the KYC policy and it is impossible to make them comply with the government’s regulations since they are not run or owned by a centralized company or small group of people.

How Bitcoin Is Taxed

Bitcoin is taxed according to the capital gains from Bitcoin transactions. The fiat currency gained from crypto trading or other crypto activities is taxed accordingly at different rates and can be called income.

Some Bitcoin activities may be taxable as income and such events can be trading Bitcoin for cash, exchanging Bitcoin for another crypto and spending Bitcoin on the purchase of goods and services.

However, always stay updated with the latest crypto tax requirements and obligations. In the US, th e latest requirement mandates all capital crypto gains to be recorded in form 8949.

Many when Bitcoin is received as a salary, it is considered income and taxable. It is also taxable when Bitcoin is received for providing goods and services. 

However, not all Bitcoin activities or situations are taxable. Bitcoin being half passively cannot be taxed and also, transferred Bitcoin gifts and donations are not taxable. There may still be some legal obligations or requirements for such activities to be reported to the IRS.

Bitcoin taxation and how Bitcoin transactions are reported depend on the country of residence. For example, US taxpayers must report crypto sales and other events that are taxable. 

What Happens When Cryptocurrency Is Unreported

It is considered a felony to make a false report or not report one’s cryptocurrency assets and transactions. The penalty for this offence can be severe and substantial.

Centralized exchanges do report directly to the IRS by issuing tax forms to the IRS. Likewise, the IRS had mandated centralized exchanges through a so-called John Doe Summons,  to catch tax evaders who try to cheat the system. 

However, those summonses are just the least of the tools used by the IRS to enforce Bitcoin taxes. According to form 1040, US taxpayers are asked specifically about involving in any transaction such as Bitcoin.

While some people may try to outsmart the IRS by not reporting such, it will be considered a serious tax evasion or fraud when they face an IRS auditing procedure.

Guilty individuals will be fined heavily or even face criminal charges which will lead to serving years of jail term. 


Bitcoin transactions are considered pseudo-anonymous because they can be traced due to the transparency of the blockchain and the ability of the authorities to track the identities of transaction parties.

Also, the KYC verification implemented by the centralized exchange platforms has aided the government in tracking crypto criminal activities, reduced the anonymity of users and also helped the IRS to keep track of crypto taxes.