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Bitcoin Storage: Which method is best for you?
After buying bitcoin or any other cryptocurrency, the next most important step is to protect it. To do so, you need a cryptocurrency wallet to manage your bitcoin and keep them secure.
There are many types of cryptocurrency wallets out there, but the essential distinction between them is whether they are hot or cold. A hot wallet is connected to the internet and can be accessed at any time. A cold wallet is a physical device that allows you to store your funds offline.
Hot wallets include wallets provided by crypto exchanges, mobile and desktop wallets. There are several types of cold wallets – but the most practical option are hardware wallets. These are USB-like devices that you use to store bitcoin offline.
TLDR Summary
Before we go into detail, this is the gist of what kind of wallet is best for you:
A hot wallet is ideal if you plan to trade frequently or hold small amounts of bitcoin. Hot wallets are a more convenient form of storage as they can be easily accessed. A cold wallet is better if you plan to hold long-term as it offers the highest form of security.
Hot and cold wallets are not mutually exclusive. Most people often go with a hybrid solution that employs both forms, such as keeping a small amount in hot wallets for trading while leaving the majority of their assets in cold storage. Another important factor in your decision is whether you want to take custody of your keys, or passwords, to your bitcoin.
With that said, let’s look at the different kinds of wallets, ordered from least to most secure. For each type of wallet, we’ll look at the pros and cons.
What exactly is a crypto wallet?
The term wallet is a bit of a misnomer, because they don’t actually “store” bitcoin. Cryptocurrencies only exist on the blockchain. All a wallet does is to store the password that proves you are the owner of a particular amount of bitcoin.
Your wallet contains both a public key and a private key. Think of the public key as your email address – your friends need to know where to send their message. The private key, similar to a password, proves you are the owner of the email address and enables you to send messages from that account.
For a crypto wallet, the public key is your wallet’s address, and your private key unlocks the assets in the wallet. And so, choosing a wallet ultimately boils down to how you want to protect your private key.
Custodial wallets
The most basic form of storing bitcoin is with a custodian. If you’ve purchased stocks from brokerages, the term will be familiar to you.
Entrusting a custodian with your bitcoin works the same way as keeping your stocks with a brokerage. You do not own the actual asset. Rather, a third-party is responsible for holding and managing your bitcoin. In this case, the third-party custodian is the exchange where you bought your bitcoin, such as CoinHako or Binance.
The key benefit of a custodial wallet is that it requires very little personal responsibility on your part. They are usually more convenient – if you forget your password to your exchange account you can easily reset it. Conversely, losing your password to a non-custodial wallet means your bitcoin will likely never be recovered.
This is a very real risk – around 20% of all bitcoin are lost because their owners forgot their key. Keeping your bitcoin with a custodian eliminates that risk. But it bears repeating that with an exchange you do not own the asset, encapsulated by the oft cited saying, “Not your keys, not your coins”.
The biggest risk of keeping your bitcoin on an exchange is losing them in a hack. Exchanges are prime targets for hackers – for example, over $40 million in bitcoin was stolen when Binance was hacked in 2019. Binance fully refunded the stolen bitcoin to users, but this may not always be in the case in the future, or with other exchanges.
Best practices
If you are going to store your crypto with a custodian, it’s best to follow these best practices. First, use a reputable custodial wallet offered by crypto exchanges that offer high security, such as those listed on our bitcoin guide. For instance, here’s how CoinHako keeps your wallet secure:
“All funds, except for a small percentage, are swept and forwarded to our cold storage accounts. Cold storage funds are stored in hardware wallets and vaulted in a highly secure location. These ‘Cold Wallets’ are offline, offer paramount security and cannot be hacked.”
It’s equally important to use good security measures to prevent hackers from exploiting vulnerabilities on your end. Some key tips include:
- Use two-factor authentication, such as Google authenticator. Doing so adds an extra layer of security to your account.
- Use an external password manager, such as Dashlane and 1Password. They can help you to store and generate secure passwords.
- Avoid unsecured/public WiFi. When you’re connected to these networks, hackers can easily steal your login details and other sensitive information.
Non-custodial wallets
The main alternative to storing your bitcoin at a financial institution is storing it yourself, i.e. a non-custodial wallet. This option gives you full control over your cryptocurrency since you are the sole owner of the private keys.
Doing so entails taking on responsibility of keeping your keys and wallet secure. Unlike a non-custodial wallet, you cannot simply click “reset your password” to regain access to a lost account.
When you set up a non-custodial wallet, you’ll need to note down your private key. The key is presented as a “seed phrase” – a list of random words that translate into a numerical password.
We can’t overstate how important it is to store this private key securely. Do not share it with anyone or store it online, especially on unsecured locations such as on Google Drive. If a bad actor discovers your seed phrase, they will have full access to your bitcoin.
Software wallets
In the category of non-custodial wallets, a software wallet is a halfway house in terms of security. Exchange-based wallets are web-based, meaning they can be accessed from any phone or computer.
Software wallets are considered to be more secured in comparison. That’s because software wallets allow you to manage your keys and store your assets directly on a desktop or mobile, and not with a centralised exchange.
While they are less secure compared to hardware wallets, a huge plus point is that there are many excellent free software wallets. Some notable products include Coinbase Wallet (not to be confused with its separate exchange product), Trust Wallet (official wallet from Binance) and MetaMask.
Hardware wallets
Hardware wallets are one type of cold storage. It’s the most secure option because your bitcoin is stored offline – and thus out of reach from hackers. A wallet cannot be hacked if it is not online.
There are several methods of cold storage, including one as elaborate as engraving your seed phrase on a metal plate. But the most practical solution is a hardware wallet, a USB-like device that you stick into your computer. Popular names in this category include Nano Ledger and Trezor.
On top of being offline, hardware wallets are secure because your private keys never leave the device, even when performing a transaction. Sending bitcoin from your hardware wallet requires “signing” a message to prove ownership of the private key. This process takes place entirely within the device. This means that even if you use a public or infected computer, your private keys should not be compromised.
There are drawbacks with hardware wallets. First is the cost. A hardware wallet starts from around $100, and goes up to $200 for higher-end models. There is also a steeper learning curve compared to the other solutions, and it’s more cumbersome to withdraw your assets to another device.
However, it’s a small investment of time and money if you plan on holding a large amount of bitcoin. If you’re considering buying a hardware wallet but are intimidated by the process, this video gives a great walkthrough of the process.
Conclusion
There is no perfect wallet. Choosing one yourself involves weighing the tradeoffs for each solution – security vs convenience.
However, there are options to enjoy the best of both worlds. For instance, you could store a small amount of crypto on a hot wallet to make trading more convenient. But you could also keep the bulk of your crypto assets in a cold wallet for safekeeping.
Check out Financial Horse’s Complete Guide – How to buy Bitcoin for Singapore Investors!
This article was submitted by a Guest Contributor. The opinions expressed in this publication are those of the Guest Author/Contributor. They do not purport to reflect the views or opinions of the Financial Horse Team.
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