CRYPTOCURRENCY PRIVATE KEYS AND COLD STORAGE
What are private keys?
A private key is what grants a cryptocurrency user ownership of the funds on a given address. Therefore, the private key is the TICKET that allows an individual to spend cryptos. It is therefore imperative that these keys are kept secure. Private keys give access to wallets. You can think of a wallet as your personal interface to the Bitcoin network, similar to how your online bank account is an interface to the regular monetary system. Wallets contain private keys; secret codes that allow you to spend your coins.
In reality, it’s not coins that need to be stored and secured, but the private keys that give you access to them. Private keys are what you need to protect if you want to keep your bitcoin safe from hackers, user error, and other possible issues. When you own cryptocurrencies, what you really own is a “private key.” Your private key unlocks the right for its owner to spend the associated cryptocurrencies. As it provides access to your cryptocurrencies, it should — as the name suggests — remain private.
Oftentimes, cryptocurrency exchanges are the best way to get some coins, but many people who use these exchanges make a mistake after they’ve gotten their tokens. They keep them on their exchange wallets instead of transferring them to a private wallet/hardware wallet. Private keys themselves are rarely handled by the user, instead, the user will typically be given a seed phrase that encodes the same information as private keys.
Some have asked me this question: Do I need to generate a private key?
Not necessarily. For instance, if you use web wallets like Coinbase or Blockchain.info, they create and manage the private key for you. It is also the same for exchanges. Mobile and desktop wallets usually also generate a private key for you, although they might have the option to create a wallet from your own private key.
So why generate it anyway? Here are some of my reasons:
- You want to make sure that no one knows the key
- You also want to learn more about cryptography and random number generation
Cold storage is usually seen as a more secure form of storing cryptos than a traditional wallet. It involves storing bitcoins offline — that is, entirely separate from any Internet access. Keeping bitcoins offline substantially reduces the threat from hackers. There is no need to worry about a hacker gaining digital access to a wallet when the wallet itself is not online.
The method of cold storage is less convenient than encrypting or taking a backup because it can be harder for users to access their coins. Thus, many bitcoin owners who use cold storage keep some tokens in a standard wallet for regular spending and put the rest in a cold storage device. This reduces the effort of digging out coins from the cold storage now and then for everyday use.
Some of the popular forms of cold storage are the Hardware and Paper wallets
A hardware wallet is a physical electronic device, built for the sole purpose of securing crypto coins. The core innovation is that the hardware wallet must be connected to your computer, phone, or tablet before coins may be spent.
The two most popular and best Bitcoin and cryptocurrency hardware wallets are:
- Ledger Nano X (review)
- Trezor T (review)
Hardware wallets are a good choice if you’re serious about security and convenient, reliable Bitcoin & crypto storage. This is because they keep private keys separate from vulnerable, internet-connected devices.
Your all-important private keys are maintained in a secure offline environment on the hardware wallet, fully protected even should the device be plugged into a malware-infected computer.
A paper wallet involves printing the public and private keys on paper. This is a way to safeguard against hackers or computer malfunction. In addition, a paper wallet may have a QR code that can be scanned and added to a software wallet to make quick transactions. Since the paper contains all relevant information needed for spending the coins, its safety is crucially important. It is usually a good idea to encrypt as well as duplicate the paper wallet for more safety.
Other types of cold storage are Sound wallet and Deep cold storage.
We have extensively discussed offline cold store so far. Let’s now take a quick dive into Online wallet (also called “Hot wallet”)
Hot wallets are wallets that run on internet-connected devices like computers, phones, or tablets. This can create vulnerability because these wallets generate the private keys to your coins on these internet-connected devices. While a hot wallet can be very convenient in the way you can access and make transactions with your assets quickly, they also lack security.
Having discussed the security challenges prone to hurt wallets, some of its benefits are that it is
- The easiest way to store small amounts of bitcoin and crypto
- Convenient; spending and receiving payments is easy and fast
- Some hot wallets allow access to funds across multiple devices
Storing tokens on exchange wallets can be dangerous for several reasons.
1) Lack of Ownership
While you can store any coins or tokens you purchase on your exchange wallet, you don’t own that wallet. Exchange wallets are different from personal wallets in that exchange wallets are ideally just hot wallets for trading. If something happens on the exchange then you don’t have any control over your coins because they aren’t in your custody, they belong to the exchange.
Cryptocurrency exchanges are the cross between decentralization and centralization. The whole purpose behind blockchain and cryptocurrency is to promote decentralization. However, exchanges are centralized, which creates many issues. Currently, the cryptocurrency world is a bit like the wild west, no one is in charge and there aren’t many rules.
3) Hacking Risk
In addition to the lack of regulation and the inability to guarantee the safety of assets, there is also the threat of an exchange getting hacked. Exchange hacks are relatively common, and due to the lack of regulation, once the coins get lost, that’s it. The owners of the coins can’t get them back from the exchange. While blockchain itself is very secure and essentially unhackable, the centralized nature of exchange makes them vulnerable.
In conclusion, it is not the smartest thing to do to keep your coins on an exchange. While they may be convenient, it’s much better to get a hardware wallet of your own to store any crypto coins you own.
If an event were to occur where the exchange is hacked or your account becomes compromised, your funds would be lost. Cryptocurrency exchanges do not provide insurance, making safe storage of cryptocurrencies especially important. As mentioned previously, it is not wise to keep large amounts of cryptocurrency in any hot wallet, especially an exchange account. Instead, it is suggested that you withdraw the majority of funds to your personal cold wallet as explained above.