One of the most asked questions by people trying to purchase their first Bitcoin is “How do I safely store my cryptocurrencies/ Bitcoin?”
Cryptocurrencies are similar to traditional fiat currencies – we use a “Wallet” to store them. However, this wallet can take varying forms – including both Digital and Physical formats. It can be tricky to navigate around how to safely store your cryptocurrencies, as there is a range of advice around the internet – some outdated, some overly complex for newcomers. In this article, we will try to break down the most common ways users can store their cryptocurrencies safely and securely!
1. Blockchain Wallets
The first type of wallet and the most basic type is a wallet that exists on the blockchain. Cryptocurrencies are stored by tracking the ownership records of a particular coin on the blockchain; when a coin is first mined, it can be thought of as remaining in place where it is mined, and a record of its ownership is created and given to the miner through his or her mining wallet.
The miner (let’s presume this is for Bitcoin) will then transfer the ownership records, publicly visible on the blockchain, when he sells or transfers his Bitcoin to somebody else. This is very similar to how fiat currencies are used as a medium of exchange for goods and services.
Blockchain wallets have a very different process from a regular account creation on your typical website. They use a system of cryptographic encryption and signing processes to move coins from one place to another. The most common term to note here is the use of private keys and public keys; they are similar to passwords and bank account details respectively. Private keys are used to “decrypt” access to a blockchain wallet, which allows the owner to change the “insides” of a wallet (such as moving his or her cryptocurrency and Bitcoin to other wallets), while public keys are restricted to viewing the amount of coins in a wallet (as well as acting as a receiving address).
Unlike traditional passwords, private keys cannot be chosen and are generated by blockchain software as part of the technical requirements of a blockchain. A common saying by the cryptocurrency community is “not your keys, not your coins” – referring to blockchain wallets as the most appropriate and secure way to store and guarantee ownership of a token.
Public keys are similar to bank account details and are also known as “Wallet addresses”, as they are like the addresses used to identify where a letter should go.
2. Exchange Wallets
The second type of wallet are exchange wallets, which are centralized wallets operated by trusted third parties or entities. Typically, a user looking to purchase Bitcoin will do so by signing up for an account on an exchange such as Coinbase, which operates the centralized wallets. These wallets are not based on the blockchain and simply represent a contractual obligation by the exchange in question to hold the purchased tokens/cryptocurrencies/coins on your behalf; there are no private keys or public keys for wallets created this way. When the user wants to retrieve the cryptocurrencies, they need to create a blockchain wallet elsewhere or generate the deposit address for another exchange wallet and initiate a withdrawal process, where the exchange will send out the tokens to the user’s chosen destination or wallet address.
Exchange wallets are often treated as less secure by the larger cryptocurrency community, due to various hacks and abuse of trust that have happened to exchanges in the past. For instance, as the user does not have true ownership of their coins, the owner of an exchange can run away with the tokens. Ultimately, the non-blockchain nature of these wallets means that a level of trust has to be placed in the exchange operators.
Nonetheless, exchanges are important to the blockchain ecosystem, as they facilitate seamless, cost-effective trading of Bitcoin and other cryptocurrencies. It is recommended to use exchanges for “hot storage”, where coins you intend to trade with or use often are stored, while coins you do not intend to touch for a long period of time can be stored offline or cold in blockchain wallets.
3. Hardware Wallets
Hardware wallets are a type of blockchain wallet that combines hardware and software. By isolating the wallet software in a further secured enclosure that is typically protected against external threats (such as keyloggers and viruses), the user can ensure that there are multiple layers of protection for their coins.
Most hardware wallets also allow for multiple blockchain wallets to be used in the same device, by generating them from a “seed phrase” – these wallets are also called Hierarchical Deterministic Wallets (HD wallets for short). They allow a user to generate a series of private keys using a phrase, usually made out of over 12 or more unique and random words in a specific order. By saving this seed phrase, a user can gain access to a large number of wallets, acting as a “master key” or backup for their individual wallets.
Hardware wallets are popular amongst users with a proportionately larger amount of cryptocurrencies, as they offer a good level of security. They do cost a fair bit for users who are simply holding a small amount of crypto.
4. Paper Wallets
Paper wallets are a common term, and refer to blockchain wallets that have been printed out as a QR code (the public key or wallet address) with an associated private key. They have a variety of uses; some people use them as cheap offline storage, while others use them as temporary wallets or “hot wallets” for use in transferring tokens to other users.
How can you be safer using your cryptocurrency wallets?
The number one cause of hacks and loss of cryptocurrencies is lack of security practices. Here are some tips that make it less likely for you to be a target of an attack.
- Don’t store naked passwords and private keys on text files, microsoft word or even paper around your house. Use a reputable password manager such as Lastpass instead.
- Avoid running wallet software directly from the browser using URL addresses, which are easily hijacked by viruses or third parties; instead, follow their best practice instructions on use. Wallet software such as Metamask are secured from within the browser and support many different types of wallets.
- Keep most of your funds in offline storage where possible especially if intending to hold cryptocurrency for the long term.
- Back up your wallets and private keys in multiple locations, as forgetfulness or fuzzy memory is more often the true enemy!