I know you asked this back in July but I found a pretty good explanation:
It's pretty easy to prove if any of your addresses are connected to your identify. Let's look at some scenarios:
Bob buys bitcoin and withdraws it from his kyc exchange account to his own wallet.
Scenario 1:
Bob then spends the money at a local shop that reuses the same address or the shop's address is associated with the owner's real world identify. On chain analytics then determines with certainty that money has changed hands from Bob to the shop using his associated identity with the account on coinbase that the bitcoin originated from, thereby alerting the IRS that Bob has incurred a taxable event.
Scenario 2:
Bob sent the bitcon to Alice, who then transferred it to her coinbase account and sold it. Onchain analytics is able to determine with certainty that money changed hands between Bob and Alice based on their associated identities with their coinbase accounts.
Scenario 3:
Later Bob uses it to pay for an online order to be delivered to his home address. His name and address associated with the order allows on chain analytics to determine he spent bitcoin and incurred a taxable event. The originating bitcoin address is now known to be owned by him.
Scenario 4:
Bob sent the bitcoin to Jake the dope dealer in exchange for some dope. Because Bob always reuses the same address when he withdraws bitcoin from the exchange, Jake is able to look up the sending address and see Bob's entire bitcoin balance. He and his boys make plans to jump Bob and force him to give them his bitcoin.
Scenario 5:
Bob sends bitcoin to a group of protesters who have gone on strike and no longer have access to traditional fiat since the government has shut that down. Government agents trace the bitcoin back to Bob through his coinbase account and show up at his door to arrest him.
Scenario 6:
Bob is a low time preference bitcoiner who simply holds long term and practices good security by backing up his keys and keeping his bitcoin in cold storage. He has not spent any bitcoin yet. Unfortunately, the KYC exchange he used got hacked and his personal information is leaked to the dark web. His address, phone, ID, and entire transaction history on the exchange is sold to a black hat hacker, who sees he owns a lot of bitcoin. The hacker makes plans to invade Bob's home with 3 other masked men. They're prepared to torture or kidnap Bob for his bitcoin.
So somebody can know where it goes if your real world identify is associated at any time with any of the addresses you use. You're open to government overreach or even malicious actors.
Here's a better scenario:
Bob logged into Bisq which is an open source peer-to-peer network for trading bitcoin privately where every bisq node is a Tor hidden service. He buys bitcoin anonymously and sends it to his private wallet where it is then sent through a coinjoin, thereby completely obscuring the origins of the bitcoin.
Now the first question isn't who did he send to? It's who sent what to who?
Bob also uses coin control in which his bitcoin stack is separated into UTXOs that are labeled so he knows where they came from and what they're used for, making it even more difficult to understand how much bitcoin he holds or who even who is holding it.
Bob sends some bitcoin to Alice who then turns around and sells it on an exchange. On chain analytics knows that Alice sold bitcoin but it cannot determine where it came from.
Bob spends his non-KYC bitcoin at a local shop. On chain analytics knows the shop received it but is unable to identify who sent it.
Bob sends bitcoin to protestors on strike. Government has no idea who gave it to them.
Coinbase got hacked leaking personal information of thousands of users. It doesn't affect Bob because he gets his bitcoin P2P.
Bob is chilling with his non-KYC bitcoin. No one can bother him or intrude on his privacy. know you asked this back in July but I found a pretty good explanation:
