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The Onion Routing research project is building an Internet-based system that strongly resists traffic analysis, eavesdropping, and other attacks both by outsiders (e.g. Internet routers) and insiders (Onion Routers themselves). It prevents the transport medium from knowing who is communicating with whom -- the network knows only that communication is taking place. In addition, the content of the communication is hidden from eavesdroppers up to the point where the traffic leaves the OR network.
This was a project started in the late 1990's by the navy. It is essentially a two stage process. The sender instructs router "X" to create an "onion", which consists of public-key-encrypted layers of instruction. Router "X" peels off the first layer of the onion, which indicates the next step in the path and supplies a decrypting key for use when the message comes through. The onion then goes on through routers "Y" and "Z", depositing keys at each stop. Once the connection is established, the encrypted message is sent through and successively decrypted, arriving as plaintext. To rspond, the recipient sendsthe message to router "Z", and it follows the pre-established path back.