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I have to admit I don't fully understand the Bitcoin protocol. But from what I do understand, transactions are traceable -- it is the main reason decentralization works: the world can watch and confirm that a transaction is legit.

Why then can't we observe when a thief tries to cash out or otherwise exchange a Bitcoin that we know to have been stolen?

As Robert Wagner writes:

1 out of every 14 Bitcoins is now stolen property, and there are plenty of laws governing stolen property.

What am I missing here? With so many Bitcoins identified as "stolen," why can't they be traced, recovered and returned to their rightful owner?

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Transactions can occur very quickly and the stolen coins can exchange hands, split up and be mixed with other coins multiple times before the theft is discovered. Many innocent parties (whether it is merchants, exchanges or other individuals) could be affected. Who is going to be holding the bag?

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you can't trace stolen bitcoins. when you move the stolen bitcoins into exchange and say exchange into dogecoin or litecoin then exchange back to bitcoins then everything would screwed all up, it's untraceable. also exchange like btc-e or bter which are not base in the u.s so the u.s can't do anything or even try to close them.

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    You don't even need to exchange to altcoins then back. Just move BTC into btc-e then withdraw and it is already untraceable because for whatever reason btc-e pays from a random address in their hot wallet pool.
    – uminatsu
    Mar 6, 2014 at 4:30
  • This is a bit like a mixing service. But you never know if the mixing service isn't keeping records which could link your input and your output to the exchange. However, the exchanges get now (5 years later) more and more regulated so you need to switch to decentral exchanges in order to protect privacy.
    – tempo
    Nov 17, 2019 at 0:17
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The answer to the first question about why stolen bitcoins can not be easily traced like regular bitcoin transactions. This is because the exchanges like btc-e magically move the coins so that tracing becomes impossible. For example yesterday I moved 15 dollars worth of bitcoins in to btc-e and traded it to litecoins, but the address where I sent those coins still today show the coins are unspent.

The answer to the second question about why stolen bitcoins can not be easily recovered is about the bitcoin protocol itself. We can not magically revert transactions without the coin holders. Recovering stolen coins would require finding the people who are holding the coins, but this is almost impossible because of the anonymity of wallet owners.

These two features allow easy protection against being caught which makes cryptocoins good target for Internet theft.

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    I don't think "magically" is an informative way to describe the process being asking about...
    – RTbecard
    Dec 31, 2017 at 11:46
  • Well it is hard to explain how exchanges keep record of their transactions since it depends on their own implementation outside of the bitcoin network. When you transfer bitcoins to exchange you might send them to one address and when you take them out of the exchange you might get them from another address. I said magically to keep my answer simple at the time.
    – Tonto
    Mar 20, 2018 at 19:44
  • we could call it black box. inside the box they could even create a fractional reserve system like we have it in the fiat world. The total number of Bitcoins could be augmented and nobody would realise unless too many people wants to withdraw funds (called bank run in the fiat world). The 'magical' moves of the traded coins inside the exchange aren't recorded in the blockchain. If now the lightning network comes into your mind - this one has the advantage the the box/channels are secured by an open source software.
    – tempo
    Nov 17, 2019 at 0:07
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Several great reasons: (1) off chain transactions do not have a public ledger (2) tumbling - repeatedly moving through different addresses quickly makes tracking difficult (3) fragmenting - your BTC gets broken up into tiny tiny pieces and spread around (4) TOR or similar IP hiding can cloak the owner of an address (5) questions of jurisdiction (6) questions of whether any crime was even committed

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I want to comment this 7 years later. In the meantime it's not difficult anymore to trace bitcoin to exchanges in the most cases. It doesn't mean that people get the stolen coins back. But it's not a question of possibilities, it's a question of too few specialists able to do so. Successfull scammers have to manage a lot of bitcoin addresses and one little mistake is enough and the privacy can be revealed. Usually one starts to find all addresses belonging to the same entity and afterwards the outbound transactions of all the addresses in the pool are analysed and the addresses on the paths are matched with known exchange addresses. Usually thousands of paths can be followed and one valid path to an exchange can already be enough to succeed. If mixers are used or privacy coins it's more difficult but still often possible because people tend to lose overview over time what coins shoudn't be spend together with others.

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