Bitcoin and Cold Storage

Bitcoin and Cold Storage
Bitcoin hardware wallet

As Bitcoin gains popularity and more widespread adoption, one of the things investors will need to understand and educate themselves about is the storage of Bitcoin. There are several options available and more options are being built, including professional custody services from leading financial institutions.

New investors may choose to leave their coins in exchanges like Coinbase. Different exchanges have different policies around how they hold clients' digital assets. Some may hold them in a common wallet, some may show proof of reserve, while some others have actually gotten in trouble for not actually holding the assets 1-1.

Serious investors should explore options to store Bitcoin. Some popular options include wallets offered by exchanges, browser based wallets, other hot wallets that are online and finally hardware wallets, commonly referred to as cold storage.

Let's first take a look at what it means to 'store a bitcoin' and how you can move your coins offline and into cold storage.

Where does the #Bitcoin reside ?

All the Bitcoins that have been minted so far, about 19.2 M as of November 2022 and counting, reside on the Bitcoin blockchain. The blockchain is secured by cryptography, so it is one of the safest ways to store your money.

How is the #Bitcoin saved on the #blockchain ?

Bitcoin is saved inside digital wallets on the blockchain. Each #wallet has a unique address. You can think of the wallet's address like an email address. It is public information and can be shared with others. For example, if someone wants to send you some Bitcoin, you can give them your wallet address and they will use that to send funds to the wallet. It is possible to create up to 2^160 unique addresses in the Bitcoin blockchain.

What is the #cryptography behind the #Bitcoin blockchain ?

The #hash function (SHA-256) is used to provide a single view of the blockchain to all users. Whenever a crypto wallet is created on the Bitcoin chain, 2 keys are generated to secure and use the wallet. A public key is the wallet's address and it is typically used to send funds to the wallet. A private key is the secret key used to gain access to the funds in the wallet.

What does it mean to own #Bitcoin ?

Whenever you purchase Bitcoin, the transaction is recorded on the #blockchain. The Bitcoin is secured by 2 keys, the public key and the private key. Whether you have and manage the keys will depend on the storage option you choose for your Bitcoin.

There are several options to saving your keys (wallet and secret private key). If you choose to leave your coins in the exchange, the keys will be managed by the exchange. You can get a public key to send and receive Bitcoin from the exchange. If you choose to store your coins in cold storage, you will get to own and manage both the public and private keys.

What does 'not your keys, not your coins' mean ?

This is a popular adage used by Bitcoiners based on past experience with Bitcoin storage. When you don't own and manage your private keys, there is a risk of losing your Bitcoin since whoever has the keys has access to your coins. For example all Bitcoin stored in exchanges are at a risk since the private keys are held by exchanges and since the Bitcoin exchanges are not regulated, there are no guarantees against theft, bankruptcies etc.

What is cold storage ?

Cold storage refers to storing the keys in an offline hardware wallet. In this scenario, you will be responsible for the private key, a 24-word secret key. This is considered the safest option to save the #Bitcoin. You own and manage your keys and hence your coins cannot be accessed by others and therefore considered safe.

What if I lose my hardware wallet ?

A hardware wallet is simply like a computer used to access the internet. The actual #Bitcoin is on the #blockchain . The Bitcoin can be accessed using the public key (wallet address) and the private key (secret 24-word key). In case you lose your hardware wallet, no need to worry! You can always set up another hardware wallet to access your coins as long as you have your public and private keys with you.

What is the Public Key ?

The public key is the #wallet address. This is how you access the coin on the chain. It is similar to an email address on a mail server. It is called public because it is visible on chain. It can be found and analyzed by blockchain analysis tools. Just like an email address is used to receive mail, the public key is used to receive funds into your wallet.

What is the Private Key ?

The private key is the secret key that is generated along with the wallet address when a wallet is created. It consists of 24 words. You can think of this as the password for your email account. It is used to access the #Bitcoin in your wallet address. However, unlike the email password, the private key can NEVER be changed.

The private key is also referred to as the seed phrase. This should not be given to anyone. Also, most importantly, this cannot be lost. If you lose the private key, your Bitcoin is lost forever, nothing can be done.

The following are some popular hardware wallets:

  1. Trezor
  2. Ledger
  3. Ngrave

In conclusion, it is important to understand the risks and benefits that come with the different options of storing the Bitcoin. Cold storage is by far the safest option, as long as you make sure you don't lose your private keys. All other options carry different levels of risks. The main reason for risks around storing in exchanges is that the crypto market is not regulated. If you do choose to store your Bitcoin in exchanges, other hot wallets, you can spread it around in multiple places to reduce the risk of losing everything.