“A fool and his money are soon parted” ~ Thomas Tusser
With Bitcoins leading the way in 2009, the world of cryptocurrencies has grown bigger and stronger over the last few years. There is increasing use and acceptance of virtual currencies, more advancement in software and systems, and rising numbers of participants. But, another thing that has been rising with the popularity of virtual money, it’s the number of hacking cases and fraudulent practices. Since the regulatory framework of virtual currencies is not yet well developed, there is no resource for the owners in case of fraud or theft. (Related reading, see: Bitcoin: Current And Future Legal Framework)
So, where do you store your Bitcoins (and altcoins)? Technically nowhere, as it’s not Bitcoins that are stored. Bitcoins are accessed through keys (addresses and codes) which are kept in a Bitcoin wallet (also known as a digital wallet). Thus, it's the digital wallet holding the public and private keys that needs to be protected by storing at a safe place. (Related reading, see: Ways To Earn Bitcoins)
There are various ways to secure a Bitcoin wallet, the popular ones being encryption, backup, multisig and cold storage; none is infallible though. The first way is to encrypt your wallet is by using a strong password. The second way is to make a backup of the wallet. Even a computer malfunction can result in a loss of Bitcoins, let alone hacking. Multisig is another method is to protect Bitcoins. It involves creating a multi-signature transaction system under which more people (usually 2 or 3) need to approve the funds being released.
What Is Cold Storage For Bitcoin?
Cold storage is another way to secure Bitcoins. It involves storing Bitcoins offline--meaning, away from any internet access. Keeping Bitcoins offline substantially reduces the threat from hackers. The method of cold storage is less convenient than encrypting or taking a backup; thus it is usually done by keeping some money in the system for regular spending and putting the rest in a cold storage device. This reduces the effort of digging out coins from the cold storage every now and then for everyday use.
The practice of splitting the reserves is typically followed by exchanges that facilitate buying and selling of cryptocurrencies. These platforms deal with huge number of Bitcoins (and like currencies) and are the targets for hackers. To minimize the amount of loss in cases where security is breached, such platforms opt to keep majority share in cold storage. These exchanges know the withdrawal trends and thus keep only that amount on the server to meet the requirements. (Related reading, see: A Look At The Most Popular Bitcoin Exchanges)
The commonly used methods of cold storage are:
- Paper Wallet is a way to safeguard against hackers or computer malfunction and involves printing the public and private keys on paper. In addition, a paper wallet usually has a QR code which 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 important. It’s usually a good idea to encrypt as well as duplicate the paper wallet for more safety
- Storage devices like a USB drive are also used to keep the secret keys. Such devices are further kept in a safe or deposit box to make sure that they don’t fall into the wrong hands.
- Sound Wallets are another way to secure the virtual currency; the sound wallet technology involves keeping the private keys in encrypted sound files in products such as Compact Discs (CD’s) and vinyl disks. The code hidden in these audio files can be deciphered using a spectroscope app or high-resolution spectroscope.
- Hardware wallets are becoming a preferred choice to secure a wallet in an offline mode. These are small devices which are water and virus proof and even support multi signature transactions. They are convenient for sending and receiving virtual currency, have a micro storage device backup and QR code scan camera. Pi-Wallet and BitSafe are examples of such hardware devices.
In addition to these cold storages, the concept of a deep cold storage service is also catching up. It was introduced by a London based company which offered the security of a bank vault for securing the keys of Bitcoins. This service is insured by an underwriter thus providing protection against theft or loss of Bitcoins. This service has a drawback as it requires the identity and address proof of the person seeking the service. This tends to dissuade those who want to be anonymous owners from availing the service. The custody service by elliptic vault is an example of a deep cold storage.
The Bottom Line
Though there has been some news about the possibility of hackers installing a backdoor in the cold storage system, the method of securing a cryptocurrency with a cold storage is still by and large the best. Web based wallets are most prone to attacks by hackers and when the web links are snipped, cold storage becomes a safe place for the cryptocurrency you own. (Related reading, see: How To Invest In Bitcoin Exchange Futures)