DEFINITION of Cold Storage
Cold storage is an offline wallet provided for storing bitcoins. With cold storage, the digital wallet is stored on a platform that is not connected to the internet, thereby, protecting the wallet from unauthorized access, cyber hacks, and other vulnerabilities that a system connected to the internet is susceptible to.
BREAKING DOWN Cold Storage
When a checking, savings, or credit card account with a traditional bank has been compromised, the bank is able to refund the lost or stolen money back to the account holder. However, if your cryptocurrency account or wallet has been compromised and your bitcoins stolen, the owner would be unable to recover his coins. Hence, the need for a safe and secure medium of storage for bitcoins and altcoins.
A bitcoin wallet stores the private keys of a bitcoin owner. The private key given to any bitcoin user is a unique string of alphanumeric characters required to access the user’s address. The address is the user’s unique ID that is required to make transactions and receive bitcoins from a sender. Two people making a transaction with bitcoin, where one is a seller and the other a buyer, will have to share their addresses with each other in order to complete the transaction. The buyer of the commodity or service sends the required number of bitcoins to the seller’s divulged address as payment, and the blockchain verifies the validity of the transaction and confirms that the buyer or sender really has those funds to send. Once the payment has been delivered to the address, the seller or receiver can only access the funds through his or her private key. It is therefore, imperative, for private keys to be kept secure because if stolen, the user’s bitcoins or altcoins could be unlocked and accessed from the address without authorization.
Private keys stored on a wallet connected to the internet are vulnerable to network-based theft. These wallets are known as hot wallets. With a hot wallet, all the functions required to complete a transaction are made from a single online device. The wallet generates and stores private keys; digitally signs transactions using private keys; and broadcasts the signed transaction to the network. The problem is that once the signed transactions have been broadcasted online, an attacker crawling the networks may become privy to the private key which was used to sign the transaction.
Cold storage resolves this issue by signing the transaction with the private keys in an offline environment. Any transaction initiated online is temporarily transferred to an offline wallet kept on a device such as a USB, CD, hard drive, paper, or offline computer, where it is then digitally signed before it is transmitted to the online network. Because the private key does not come into contact with a server connected online during the signing process, even if an online hacker comes across the transaction, s/he would not be able to access the private key used for it.
The most basic form of cold storage is paper wallet. A paper wallet is simply a document that has the public and private keys written on it. The document is printed from the bitcoin paper wallet tool online with an offline printer. The paper wallet or document usually has a QR code embedded on it so that it can easily be scanned and signed to make a transaction. The drawback to this medium is that if the paper is lost, rendered illegible or destroyed, the user will never be able to access his address where his funds are.
Another form of cold storage is a hardware wallet which uses an offline device or smartcard to generate private keys offline. The Ledger USB Wallet is an example of a hardware wallet that uses a smartcard to secure private keys. The device looks and functions like a USB, and a computer and chrome-based app are required to store the private keys offline. Like a paper wallet, it is essential to store this USB device and smartcard in a safe place, as any damage or loss could terminate access to the user’s bitcoins. Two other popular hardware wallets include TREZOR and KeepKey.
Finally, users looking for cold storage options can also opt for offline software wallets, which are quite similar to hardware wallets but are a more complex process for less technical users. An offline software wallet splits a wallet into two accessible platforms – an offline wallet which contains the private keys and an online wallet which has the public keys stored. The online wallet generates new unsigned transactions and sends the address of the user to the receiver or sender on the other end of the transaction. The unsigned transaction is moved to the offline wallet and signed with the private key. The signed transaction is then moved back to the online wallet which broadcasts it to the network. Because the offline wallet never gets connected to the internet, its stored private keys remain secure. Electrum and Armory are often quoted as the best offline software wallets in the cryptoeconomy.
Cryptocurrency users should ensure that the wallet of their choice is compatible with the coins they transact or trade in, as not all wallets support all cryptocurrencies.