The world of Bitcoin has been changing quickly. For those who might not know, this is a digital currency, which makes it very different from traditional currency options such as the dollar. Bitcoin operates using a decentralized, distributed network. This means that there is no central arbiter who controls when or how the money is used. In this manner, there is no way to simply print more Bitcoins out of thin air. Instead, Bitcoin is mined and released to the rest of the network. In this manner, there is a set number of Bitcoins that will ever be released. As a result, Bitcoin is not subject to the same forces of inflation and deflation that govern other types of money. This is one of the many reasons why Bitcoin, despite having a lot of volatility in its daily trading, has been on a generally upward trajectory since its inception more than 10 years ago.
While Bitcoin is also very different from other types of currency, it also faces a number of similar issues. One of the biggest issues that people who use Bitcoin face has to do with where and how they can store their money safely. With traditional currency systems, there might be a way for recourse if something goes wrong. With Bitcoin, this is not the case. In this manner, if someone loses their Bitcoin assets, there is no way to roll them back. Instead, many of these issues focus on prevention. Preventing the loss of Bitcoin is one of the major goals of everyone who uses Bitcoin. The way this is handled is cold storage.
Now, when it comes to Bitcoin, cold storage is an important subject that also has a very steep learning curve. Therefore, it is important for people to learn as much about this concept as quickly as they can. The sooner people learn about this concept, the better they will be able to protect their assets. That is where this article picks up.
When Bitcoin Users Should Use Cold Storage
The first thing that people need to learn about Bitcoin and cold storage is when this should be used. Like other tools that exist in the world of Bitcoin, it is possible to misuse cold storage if people do not understand how it works. Therefore, there are a few specific situations during which cold storage should be used. These include:
- The user has to store significant amounts of bitcoin in a secure manner
- The user needs to have infrequent but secure access to the Bitcoin funds
- The user is willing to take responsibility for the security of the funds instead of trusting the security to a third party
These are a few of the most important situations during which someone should use cold storage for Bitcoin. It is important for all beginners to pay close attention when it comes to Bitcoin and cold storage because, when people first get used to the concept of Bitcoin, they run the risk of accidentally losing their funds through mistakes that involve cold storage. For example, it might be a good idea for anyone who is new to the world of Bitcoin to practice using this method using pocket change before storing larger sums of money.
Having the Keys to the Kingdom
Now, it is important to take a closer look at how Bitcoin is passed from person to person. While people who use the Bitcoin network often talk about the concept of owning Bitcoin, this is a misleading use of the term. A better to think about coins in the world of Bitcoin is to consider the relationship between a tamper-proof vault that has been designed to hold paper bills. The vault is able to dispense cash to anyone who knows the key that is required to open it. The morality of the person trying to access the funds simply does not matter. The vault is able to dispense cash to anyone who has the private key and it will accept an unlimited number of attempts to open it. Now, it might be possible for someone to simply guess the private key; however, in the world of Bitcoin, this is next to impossible. Private keys have dozens of characters and a brute force attack would take a lifetime. In this manner, the only way someone might be able to access someone else’s vault is to steal the key from the person or convince the person to surrender it.
Now, Bitcoin stores funds using an electronic form of an imaginary vault. This is called the address. The funds at the address can be unlocked and released as long as someone knows the private key to open it. While Bitcoin seems complex to someone who might be new to this world, there is a simple rule that everyone should follow when it comes to this unique network. Everyone has to keep their private keys and addresses secret when they store their funds. Furthermore, people need to make sure that keep secure backups of all of their keys so that they do not lose access to them. Unlike a banking system, there is no room for recourse if something goes wrong. As a result, there is a greater degree of responsibility when it comes to Bitcoin and private keys in the digital world than in the physical one.
In the World of Bitcoin, Data is Money
Now, how do people handle Bitcoin in the digital world. Well, to a thief who is trying to break into the network, the private keys in the world of Bitcoin are more than data. They are actually money. There was a recent case that was published of a website that was designed and repurposed to actually steal funds from people who use Bitcoin. When people used a service titled Listen to Bitcoin, this popular service was designed to track any and all transactions that took place on the Bitcoin network. Each transaction that was completed on the network lead to a soothing chime that was synchronized to an animated bubble. Now, the creator of this unique website sold it; however, problems started to arise with it shortly thereafter. The website had been designed to hijack people’s private keys on the network. Now, this is far from the only scheme that was reported to work this way and there were countless victims who were stolen from along the way. The anonymity and speed of these attacks should be enough to cause everyone to pause before they decide to hold large sums of money, including Bitcoin, in a single place. It is easy for people to lose a large amount of money through schemes such as this.
How Do Private Keys Work?
Now, it is important for people to understand how their private keys work. The vault doesn’t actually require someone to possess the key in order to enter it. Instead, the vault simply asks for people to prove that they have the knowledge of the key. Asking for the key directly is not really possible in the digital world, so the vault asks for a proof of knowledge instead. This is how private keys are designed to work.
Take an example of private keys as proof of the method. Someone wants to send 10 bitcoin (BTC) to someone else. In order to make this payment, the Bitcoin network requires that person to publish a written promise to pay the other person the agreed amount of 10 BTC. This type of promise is called a transaction on the network. Now, Bitcoin does not know anything about real-world identities of the people involved, so Bitcoin wallet addresses are used instead.
Eventually, the transaction is carried out and the transfer takes place. The transaction posts to the blockchain in an immutable way and is stored forever. The blockchain does not use names but addresses instead. In this manner, Bitcoin has been designed to prevent theft by using a digital signature that is there forever.
In this manner, the private keys and addresses are used to carry out transactions. They provide proof of funds that have been transferred. At no point are the actual identities are revealed to the people completing the transactions or the network; however, anyone who has the private key is able to take funds from someone else and spread them without permission. While some people might like the anonymity, this is also one of the biggest risks of using private keys. Those who have the keys can spread someone’s funds to other people. This is why people need to make sure they are secure.
Taking a Closer Look at Hot Wallets and Cold Storage
Bitcoin wallets are how people carry out transactions on the Bitcoin network. In order for a payment to be made, there are four basic tasks that the Bitcoin wallet has to carry out. These include:
- The wallet has to generate and store one or more of the private keys involved
- The wallet then has to create valid transactions on the network
- The user has to find a way to digitally sign the transactions using the respective private keys
- The signed transactions then have to post to the network
The wallet has to be able to carry out all four of these tasks, which leads to a major security issue. The private keys are kept on a network that is connected to every computer that has internet. In this manner, the network is also vulnerable to attacks; however, the network is also needed to broadcast transactions. This is where the problems start to arise.
One of the tools that Bitcoin users might use is called a hot wallet. This is a wallet that combines all of these functions onto a single system that uses a single computer. There are many hot wallets that find a way to encrypt their keys in order to deter their use if they are stolen; however, no encryption scheme is perfect and the threat is still there. Therefore, people should start to notice that there is a balance between security and convenience.
So, how is this security issue with hot wallets resolved? This is where cold storage comes into play. Cold storage is a form of quarantine. This is an offline environment that has been designed to hold all private keys. The keys remain secure against network attacks because they are isolated from the network. Think of this as a safe that cannot be accessed through an attack that uses the internet.
So, how does this process unfold? It starts with an unsigned transaction that is carried out on an online device. The transaction shifts to a USB that is removed from the network. That is where it is signed. Then, the signed transaction is moved back to the network where the process is finished. IN this manner, the most dangerous part of the transaction is carried out offline.
Now, both hot wallets and cold storage are able to be used together. This is similar to having both a checking and saving account. These cold storage funds are held in a secure manner but they are also hard to access. In contrast, hot wallets are not exactly safe but they can be spent at a moment’s notice. This is how the problems are rectified.
An Overview of the Hardware Involved
Now, it is time to take a closer look at the hardware that is involved in this process. An offline environment is one of the major keys when it comes to cold storage. This requires an offline computer that is used to generate keys and sign transactions. Then, there has to be an offline storage medium that is used for holding private keys. These offline computers have to be stored with a wide variety of security features. Depending on the budget, these security features can be ramped up.
One of the ways that an offline computer can be ramped up is to permanently remove it from the network. This is commonly called an air-gap computer. They contain secure operating systems, such as Linux. Many of them use hard drives that are encrypted.
If there is not a dedicated offline computer, it is possible to use media that can be removed from a network computer such as a CD or a USB. There are plenty of options that support this method. It is also important to find ways to store private keys separately. Some of hte optoins include plastic cards, hard drives, and even human memory. Even if private keys are stored on a hard drive, it is important to think about using these other forms of media as a backup option.
Cold Storage in Practice
Now, it is time to take a closer look at the method of cold storage in practice. First, cold storage methods can be broken up between two large categories based on how private keys are stored. The first is called a manual keystore. With this method, the user maintains a group of private keys under his or her direct control. The other method is called a software keystore. With this method, the security of the private key is under the total control of software programs.
First, the Manual Keystore
The first option is the manual keystore. This provides users with flexibility and minimalism. At the same time, the user is responsible for the private keys. Some people prefer this method because it allows them to use physical tokens which are easier to use. In order to set up a manual keystore program, there are a few steps involved. These include:
- Take an offline device and use it to. generate one address/private key pair for every cold storage address that will be used. Many tools are available to make this happen.
- Next, transfer one copy of each cold storage address/private combo to the offline device that has been chosen such as paper, plastic, or USB drive. This is going to act as the keystore.
- After this, move funds from a wallet or exchange to each of the assigned cold storage locations.
- In order to spend the funds, they need to be transferred to a hot wallet to sign a transaction using the key and address pair
Now, it is important to note that the last step is required to spend using a manual keystore. This is a secure method because the funds require a private key in order to be moved.
Next, the Software Keystore
It is easier to set up a software keystore because this can be done automatically using a program. There are plenty of programs out there and this is great for people who are worried that they might not be able to keep track of the keys on their own; however, they are also placing a tremendous amount of faith in the software program. Therefore, all users need to read reviews and study the software keystores carefully before they make any decisions on which software keystore they are going to entrust their private keys to.
These are the two most common methods of storing private keys in a secure manner.